Bookkeeping vs Income Tax Reporting

by Nicole
(Alberta)

Bookkeeping is different than tax preparation.

I'm starting my new business with bookkeeping and am kind of having a bit a brain lapse that I'm hoping you can help me with.

I'm mainly familiar with QuickBooks (personally I have no use for Simply/Sage!); however a new client of mine...originally she was using QuickBooks - they had a bookkeeper come in to fix everything and switched to Simply. They weren't happy with this bookkeeper and were wanting me to fix everything as well as continue for them from this point on. Now, since I am much more familiar with QuickBooks, they were agreeable to going back to QuickBooks and they also said that I may need to just start from scratch - from what I can see, she started this company just in Nov. 2011 so it's more or less all of 2012 that I need to worry about.

My concern is, when it's a sole proprietorship and a business run out of your own home - do you record the costs of say...mortgage, utility bills, phone, etc. anywhere? I know this is rather an amateur question to be asking, but I've mainly dealt with small corporations. My issue is, I know that you can claim this sort of thing when filing your income tax, I'm just not sure how/if you record it in your books anywhere.

Another situation that stumped me is when, as an example - say she bought a meal or some office supplies, that surely can be written off in her income taxes but how does that get recorded when it was just paid with cash/personal account. This also goes for the mortgage/utilities; if they are paid with a personal account rather than the business account, how does this get accounted for?

I hope this makes sense, and I really appreciate the last time how you replied so quickly! :D

Thanks again,

Hey Nicole,

I am going to assume you are only doing the bookkeeping and not the income tax preparation. However, sometimes to be a better or great bookkeeper, it helps to know where all your hard work is going to end up ... so we'll talk a bit about taxes for the sole proprietor which is different than tax for a corporation.

Take a look at the CRA tax schedule T2125. You will see a section titled, "Calculation for business-use-of-home expenses". This is where any expenses relating to the running of the home office will be claimed. There is no need for you record any of these tax deductions while doing the bookkeeping for a sole proprietor. It will be handled at tax preparation time.

With regards using personal funds to purchase business expenses ... this is not a great habit to get into. In my chat on audit trails, I talk about how important it is to separate your personal expenses from your business expenses. It not only increases the cost for the client of having their books prepared, it invites CRA to audit your personal expenses during a business audit if/when that happens. It also increases the chances of understating income or overstating expenses ... both no-nos.

That said, the best way to record business expenses paid with personal cash is to start an "Owed to Owner" current liability (credit card type account for ease of reconciliation purposes) in QuickBooks. You can see my thoughts on how to use this account in my chat on audit trails as well. Just type "audit trail" in the site search box and the chat will come up.

There are very specific rules about what types of meal purchases should be recorded in the books. Follow the T2125 link above and look for item 12 under "13 Items That Are NOT Deductible On Form T2125". Then read item 4 further down the page under "8 Tax Deductions With Limitations". Be sure to read the notes on GST and Meals as you need to make some adjustments to your GST/HST return (if they are GST/HST registrants) before you file it.

Good luck!

P.S. I would like to remind you there is a difference between information and advice. The general information provided in this post or on my site should not be construed as advice. You should not act or rely on this information without engaging professional advice specific to your situation prior to using this site content for any reason whatsoever.

Comments for Bookkeeping vs Income Tax Reporting

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Jan 29, 2013

What a mess!
by: Nicole

This is my issue...say when another employee is purchasing supplies out of their own pocket, how does this get recorded?

I'm trying to redo entirely this clients books since they are quite the mess. They were told by another bookkeeper to record it through "Petty Cash" however, they don't actually have a float set up. Should I still do it the same way as you suggested?

Another accountant suggested to add all the same type of expenses together (such as meals, supplies, repairs, etc.) and just enter that monthly total against the shareholders loan - Debit the expense and Credit the shareholders loan. Well I'm thinking she does this with small corporations but how about sole proprietor?

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Okay Nicole, first thing I recommend is to take a deep breath, hold it for the count of four and exhale slowly.

If this was my file, on a going forward basis, I would request the sole proprietor complete an expense report with all the receipts attached for all business expenses funded from personal funds. The expense report should note whether a reimbursement is wanted or not.

I would record each entry from the expense report to the "Owed to Owner" credit card type I mentioned you should set up. This account is very similar to the shareholder loan account the accountant was suggesting. You are correct in that shareholder loan accounts are for incorporated businesses.

When doing backwork, I still record all these expenses through the "Owed to Owner" account. Doing this gives you two options:

1. You can write a cheque to reimburse the sole proprietor at various times throughout the year; or

2. You can analyze the account at year-end and clear contributions to the Owner's Contributions Equity account and withdrawals to the Owner's Draw Equity Account.

Another benefit of using the "Owed to Owner" account is, as I mentioned previously, it can be reconciled.

If/when the sole proprietor makes an actual owner's draw ... by that I mean actually writes themselves a cheque or transfers funds to their personal account, I tend to code these directly to the Owner's Draw account. I don't run these through the "Owed to Owner" account.

As a general rule, the "Owed to Owner" account should be zero at year-end unless the amount is going to be repaid to the sole proprietor.

While I prefer the accountant's method over using petty cash, I don't like running manual totals and then inputting them. I find it hard to trace the amounts during an audit or if the owner asks questions ... and paperwork sometimes "walks away" when returned to the owner.

My preference is to input each expense.

Hope this helps.

Feb 11, 2013

What about...
by: Anonymous

What about if the owners are purchasing fuel (example) with cash - is that really considered personal expense? Does this need to be recorded anywhere in the books or should it just be kept for claiming on income tax?

The other issue - I am informed that they are sole proprietors, however I am noticing that in the beginning of the year, the sole proprietors husband was receiving "advances". This makes sense to me if it were a partnership, but it's all under her name. Halfway through the year then the husband was on the payroll.

Does it make sense to create another "owners draw" account with his name on it or is that contradicting?

My other thought was to create it as though he was paid through payroll since I would imagine he should be claiming these advances as income anyway. To me - if a cheque was made out to anyone, there should be a bill or invoice to cross reference it to - this is not the case.

Feb 12, 2013

My response to
by: Lake

Hmm, okay you are asking a lot of questions but the questions themselves are confusing ... so I'll just chat. If at the end of the chat, I haven't answered your question, please post back and reclarify what it is you are asking.

Let's start with ... don't confuse where the funds come from with how to record the expense. If the cash purchases of fuel relate to a business expense, they should be recorded on the books as a business expense. How you record them depends on (1) how the purchase was funded; and (2) whether the purchase was 100% business or had a personal use component to it.

Next, don't confuse the different business structures and how remuneration occurs in each one. If the business is truly a sole proprietorship and not a partnership, any "advances" to the husband would be recorded as draws to the wife, assuming the wife is the sole proprietor and the husband is not legitimately employed in the business.

If the husband is an employee, then provincial labor laws on when they are paid kick in as well as source deduction remittance responsibilities.

A key concept attached to being a sole proprietor is that you are the business ... as opposed to a corporation that has its own separate legal identity. This means the sole proprietor is taxed on net profits. This means they are free to "remove" as much cash from the business as they want without tax consequences because only the net profit is taxable. That's why it is very important for sole proprietors to put cash aside to pay income taxes, GST/HST collected and payroll taxes payable.

When working with small business owners, the bookkeeper should take the time to speak with the owner to determine what is happening and why. Have a conversation with the owner to determine the facts. Then record your entries based on that documented conversation.

Feb 13, 2013

Sorry for the confusion!
by: Anonymous

You explained it very well, thank you! I guess what my issue is that I have the least amount of experience with sole proprietors and I think I more or less just confuse myself on it.

From what I can see, when it comes to their expense receipts, they're not being paid from their business chequing account. For example, it looks as though fuel, office supplies, etc. someone is paying with cash. I can see from their cheque stubs that the husband was reimbursed for misc. expenses but I have no way of knowing (until I discuss with them) which exact receipts were reimbursed. Then when I look at what the previous bookkeeper had done in simply accounting was enter every receipt as a bill, differently every time with no consistency. I can not go off what they did.

As for the husband being an employee, I asked him about it and he said that he was on the "payroll" all along - however I don't know who's mistake this was because I am pretty sure for the first half of the year, taxes were not deducted from any of his "advances". So, I'm figuring he is going to have to pay quite a bit in income tax. But when you mention remittance, will this affect her payroll liabilities since nothing was accounted for?

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Hey, let's start with your comments on the husband being on the payroll.

If you are experienced in corporate bookkeeping and payroll for it's employees, payroll for sole proprietorships is no different. In B.C. there are very specific rules on how and when you give an advance. If the advance is not deducted from the monthly pay cheque, payroll deductions must be taken at the time the advance is provided. You'll need to check your province's rules. If these problems relate to 2012, your T4 summary will show the discrepancies. You can expect a PIER report along with penalties and interest. You will need to file the PD7As for each month an advance was given and accept that late filing penalties. That said, I would check in with the owner to see if in fact it is her understanding that her husband is an employee. You could also check the CRA My Business Account if you have authorized access. If there is a payroll account, you will see it there.

My preference would be to run all cash receipts through the "Owed to Owner" credit card type account I explained earlier. If the husband submits actual receipts, I would run these through a "Owed to Mr. Smith" credit card type account. That way you aren't having to match invoices and receipts to actual expenses. Any reimbursement of expenses would be made through either of these accounts as appropriate. That's how I would handle it.

You can't undo what the previous bookkeeper, but you could reclassify any of these types of entries to the above accounts.

Hope this helps. Post back if you have more questions.

Feb 19, 2013

Never ending...
by: Anonymous

My next issue...the husband has been receiving reimbursement for "expenses" - to me, they look as though he is still receiving advances but they're wording it as expense reimbursements. I think this would be fine and all, as long as if the receipts for submitted and can be correlated with the cheque made out to him. So far, I'm not seeing this and the amounts conveniently are nice round numbers.
How do you suggest I go about with this?

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As I said earlier, my preference ... if the husband submits actual receipts, would be to run these through an "Owed to Mr. Smith" credit card type account. That way you aren't having to match invoices and receipts to actual expenses. Any reimbursement of expenses would be made through this account.

This should show you if you have all the receipts ... the account will clear to zero if you do. If that is not the case, and it sounds like it isn't, clear the unsubstantiated balance to the "Owner's Draw" account as a personal expense. What this means is that the sole proprietor is losing tax deductions due to no supporting documentation.

That's how I would handle it. It is not uncommon for a husband to run some errands for their spouse when the business is starting up or is in its early stages.

If you feel they are actually being dishonest and trying to avoid taxes, it would be appropriate to explain the rules and consider letting the client go.

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