Benefits of Good Bookkeeping Practices

What's in it for YOU? ... Money in Your Pocket

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... Do you ever wonder if you are following the right bookkeeping practices? You’re organized. You keep up with the paperwork. Do you just cross your fingers and hold your breath hoping that the tax assessor won’t come calling? I mean, how is a person to know, really?

Or do you ignore good bookkeeping during the year and drop a box, bag, or whatever at your accountant’s doorstep at tax time ... after hours of searching every nook and cranny in your house and vehicle for receipts, bank statements, that darn letter from the government? What a headache!

By law, every business owner must keep a complete and organized set of books and records. It’s a financial catastrophe in a tax audit if you have inadequate supporting documentation. Don't even consider not filing your return every year. That leads to costly late filing penalty charges. That would definitely not be considered good bookkeeping!

For those of you who are interested in the why and how come ... you might like to know that good bookkeeping follows generally accepted accounting principles (GAAP).

If you keep your books solely for tax preparation purposes, tax experts suggest you establish this simple method to meet this requirement.

At the beginning of each calendar year, take an envelope (or file folder) and write on the front -- the year, the tax line number, and the expense name. Do this for every line you will be submitting a tax claim for.

Throughout the year, place all your corresponding business receipts in the appropriate envelope.

At the end of the year, run a tape listing every receipt for each envelope. Write the total expense for that line on the outside of the envelope. Insert the tape in the envelope.

If you want to have access to your information in the future, you could use a program such as QuickBooks like a calculator. Then instead of running a tape listing, you would print out a report for each expense line and place it in the envelope ... just setup a bank account called cash and be sure to enter all your sales through Sales Receipt and all paid bills through the cash account using Write Cheques. You won't have a set of books prepared in accordance with GAAP or ASPE, but you should have all the information you need to file your tax return.

Keep all envelopes pertaining to one tax year together in a box. If you are audited, you've got everything you need to support your return. It's not however the best way to implement good bookkeeping practices in your business.

Find other filing organization options if you want to use your records to help you run your business too.

Before discussing what constitutes good bookkeeping practices, let’s look at some of the benefits to you when good bookkeeping processes are in place. I’ll follow that up with a peek at the consequences of poor bookkeeping practices.

You expect more from your bookkeeping system than just being able to prepare your annual tax return and meet ongoing business taxes. You expect your time, effort and money to produce information for you to run your business.

There is no need to worry about money matters within your business because you know your system is providing accurate and timely data that you use regularly to run your business. You have a plan in place for when cash flow is tight. Because you are organized, you have time left over for a life outside your business.

Your bookkeeping system strengthens your decision making and improves your bottom line because you have developed a relationship with your bookkeeper and taken the time to learn what the numbers mean. You know your sales activity and gross profit. You know the major category of expenses that drive your business and review them regularly to ensure you are still on budget.

You are no longer frustrated by being in the dark about your finances. No more crossing your fingers and holding your breath that you have enough cash to run your business. Good bookkeeping puts you in control of your cash flow. You reconcile your bank and credit card statements every month. If you go into (preauthorized) overdraft at the bank, it is pre-planned and only short term.

You can and do pay your bills on time. You invoice your clients promptly and follow up if payment is not received on time. You can place your hands on source (original) documents whenever you need them. No hunting. No going through piles of paper on your desk. No rummaging in drawers full of unfiled receipts and invoices.

You have developed a routine that allows you to tame the paper jungle. You personally set time aside to do the books, or have help because there aren’t enough hours in the day for you to do it all. Once all your receipts and invoices are input, you practice not only good bookkeeping, but great management skills. How? You run reports to make sure there are no errors and that the reports make sense.

Your bookkeeping system is simple; the right size and fit for your business. You have a pretty fair overview of the accounting process and how it works. You use your customized reports to make business decisions, prepare budgets, and review your past history so you can forecast the future plans of the business.

You use your bookkeeping system to track your advertising and marketing dollars to sales. You monitor your overhead expenses ensuring they are not increasing faster than your sales. You use available reports to collect your accounts receivable, manage the payment of your bills, and keep an eye on your inventory levels.

I'm here to tell you ... ALL of the above scenarios are achievable if you have good accounting practices in place. Now ...

... what is the downside to your business without good bookkeeping practices?

Many small business owners run into trouble because they do not keep adequate books and records. This can be expensive in the long term. It is for this reason that this group of taxpayer is most likely to get audited by the Canada Revenue Agency (CRA) or the Internal Revenue Service (IRS).

The CRA and IRS have developed their own databases to select returns to be audited. They will compare your tax return against known filers who have a verified history of non-compliance and against filers who have a proven history of compliance. If your return falls within the appropriate parameters, it will be flagged for an audit.

"When you help others to avoid paying taxes, you support the underground economy" …

"The underground economy undermines the competitiveness of businesses and individuals because it offers an unfair, illegal advantage to those who fail to comply with Canada's tax laws."

"It undermines the integrity of our tax system.”

During the 2007-2008 reporting period, CRA performed 17,300 underground economy audits. It only takes one audit to change your life forever ... there is no going back ... you may want to check out the convictions posted on the CRA website where they name names for a reality check.

CRA has a voluntary disclosure program to encourage you to self-correct past returns ... or if you haven't filed past returns ... with no prosecution or penalties. You must apply before CRA has makes a demand request.

• not registering for GST when you meet the threshold,
• not filing GST returns,
• understating sales by not reporting all your income, and
• overstating expenses to create zero profit or a loss.

Pssst ... Not reporting part of a business activity is called skimming as opposed to moonlighting which is not reporting a business activity. Need I say that neither is considered good bookkeeping! ... in fact these activities are illegal ... keep on reading for more information.

Did you know there are only five ways to pay no taxes? If you are running a successful business, expect to pay some taxes.

Auditing for Non-Compliance

On the Revenue Canada website, they are very open about how and why they conduct audits. Here is just a bit of information regarding the type of audits they may perform. Many of these audits are performed on the self-employed, unincorporated, work from home business owner as they are a high risk group.

“It is a myth that operating in cash and failing to keep records makes you immune to taxes. If your lifestyle is not in line with the income you report, and you cannot explain the difference, the CRA can assess taxes based on indirect or alternate methods of calculating your income.”

You can read about a recent CRA 2010 conviction in the area that I live in ... to see the consequences of tax evasion.

I think it is just a lot less work to practice good bookkeeping and keep an honest set of books ... with the added benefit that you sleep better at night.

Generally, five different audits for occupations and industries that deal with a lot of cash transactions are performed each year.

They match your information with third party sources from financial institutions, employers, and spouses. According to their website, in 2006-2007, $448 million dollars in additional tax assessments was generated by following up on 820,000 returns.

The CRA follows up and investigates leads they receive from enforcement agencies, tax authorities and informants regarding Canadian taxpayers who are suspected of not fulfilling their tax obligations. In 2008, they investigated over 22,000 leads.

If you fail to provide the CRA with adequate documentation to support your claims, other available information will be used. This method is often used if people in the service industry have not kept adequate tip records.

The CRA has the ability to look at industry and regional salary averages in a particular trade. If your reported income is considerably below the average or your expenses are notably higher than the average, you may be asked to provide supporting documentation.

A net worth or lifestyle audit may be conducted if your reported income does not fit your lifestyle. (A very scary thought if you are skimming.) If there is not a match, they may declare income to match the reality of your holdings.

CRA's publication, Making a Difference for Canadians, explains their approach to tax administration, how they deter non-compliance and enforce legislation.

The IRS use an income analysis that examines whether the unincorporated business owner's personal living expenses plus reported business expenses exceeds the reported income.

The IRS can use the Discriminate Index Function program to score audit potential of small closed corporations. It was updated in 2012. A study of 2010 tax returns with corporate assets under a quarter of a million dollars is planned to assist in revising the Discriminate Index Function formulas to improve small business tax compliance.

The Bookkeeper's Audit Proofing Tip

If CRA (or IRS for that matter) ever decides, during a tax audit of your business, to do an independent verification of income on your tax return, they can look at all of your family's personal bank and credit card accounts.

One way to audit proof yourself is to keep your source documentation (or a log) of all deposits and transfers made between family member accounts ... this is especially important if you or other family members like cash transactions.

Remember to log any cash gifts that your children received from their grandparents, aunts or uncles ... or the money from friends finally repaying amounts owed to you.

Why? So you have proof that it is not income. It is in your best interest to always create an audit trail for these types of transactions by doing an electronic transfer of funds or writing a cheque. This is a good bookkeeping practice too!

Also, consider starting a file (paper or electronic) for each family member that contains their bank statements, credit card statements, RRSP contributions, and investments made. It will avoid you having to pay the bank for copies during a tax audit.

Because we have a self-assessing tax system, the burden of proof lies with the taxpayer not with the CRA ... in other words, you are guilty until you can prove you are innocent. Audit trails and original, readable source documents go along way to proving this.

Source: TaxDetective.ca

Tax Avoidance and Good Bookkeeping

As a taxpayer, you have the right to legally arrange your affairs to pay the least amount of tax but you do not have the right to illegally avoid or evade tax.

CRA's publication IC88-2 General Anti-Avoidance Rule - Section 245 of the I.T. discusses tax avoidance and gives specific examples of what is and is not anti-avoidance.

Once you deliberately understate your taxes, you have crossed the line and committed tax evasion. Tax evasion is a criminal offense and the CRA does prosecute.

CRA's enforcement project, called Project Trident, targets and prosecutes individuals and companies involved in fraudulent tax schemes. You can find CRA tax alerts, leads, convictions (they name names), revoked charities, three types of fraud CRA is actively pursuing - tax preparer fraud, charity fraud and identity theft on their project page.

Gross negligence (making a false statement or omission on your tax return through “willful blindness”) is assessed very expensive penalties and interest charges. What is willful blindness you ask? Wikipedia describes it as willful ignorance or contrived ignorance.

At the very least, if you are disorganized in your record keeping, it is very likely you are overpaying your taxes due to missed tax deductions and lost receipts. In this case, hiring a bookkeeper to do a task you never get around to actually saves you money in the long term.

In the end, bad bookkeeping practices are very expensive and result in additional expenses and / or losses to your business. It could lead to years of financial problems, headaches and increased monitoring by CRA.

On the other hand, good bookkeeping practices can help ensure that future tax audits go smoothly.

So What are Good Bookkeeping Practices?

I like to break good bookkeeping practices into five categories:

1. be organized;
   
   
2. have an audit trail;
   
   
3. use computer software;
   
   
4. reconcile your bank statement, credit card and vendor statements; and
   
   
5. comply with retention requirements.

We’ll have tea ... and chat about each one of these on the coming pages.

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