Benefits of Good Bookkeeping Practices

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

by L. Kenway BComm CPB Retired

Let’s chat today about how good practices for your bookkeeping benefit you and puts more money in your pocket. In case you are keeping count, this is item six in the series (see below).

Grab your cup of tea (Okay don't grab. Mind your manners and pick it up nicely.) ... sit back, take a sip. Now take a deep breath and relax. Focus here. Bring your mind on this page right now ...

So What are Good Bookkeeping Practices?

I like to break good bookkeeping practices into seven categories:

Click on an image to go to the chat.

Requirement of Law

By law, every business owner must keep a complete and organized set of books and records.

A good bookkeeping practice to start your set of books is to keep your business expenses separate from your personal expenses. (See the audit trail article to find out how.)

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).

As a business owner, you are also legally required to collect and remit payroll sources deductions and GST/HST collected (or any sales and use tax). These funds do not belong to the owner and/or the corporation and should not be used to finance your business.

See an excellent August 15, 2012 article by Greer Jacks at the Knowledge Bureau titled "Distinguished Advisor: “Due diligence” defence for directors is no sure defence" on due diligence and what the court had to say. Go to KnowledgeBureau.com> eTools> Knowledge Bureau Report> Breaking News Archives or Back Issues> August 15, 2012.

CRA & IRS Auditing for Non-Compliance

Most non-compliance issues are examples of what is NOT good bookkeeping practices and relate to:

• not registering for GST when you meet the threshold, (the equivalent in the U.S. are sales and use taxes)
• not filing GST returns, (or sales and use returns in the U.S.)
• understating sales (see sidebar) by not reporting all your income, and
• overstating expenses to create zero profit or a loss.

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

Perhaps you are wondering if CRA/IRS looks at your personal bank deposits during an audit of your business. The answer is yes ... but it goes further, they can even look at your lifestyle ... keeping reading to learn more.

On the Revenue Canada website (see IRS sidebar), they are very open about how and why they conduct audits. Many of these audits are performed on the self-employed, unincorporated, work from home business owner as they are a high risk group. In fact, 98% of Canadian businesses have less than 100 employees.

Here is just a bit of information regarding the type of audits they may perform.

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 2012-2013, $715 million dollars in additional tax assessments was generated by following up on returns. Source: Annual Report to Parliament 2012-2013 - CRA page 22
  
  
• The CRA audited 10,822 underground economy files and assessed $305 million in taxes in 2012-2013, up 17% from the prior year. Source: Annual Report to Parliament 2012-2013 - CRA page 49
  
  
• 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 2011-2012, they conducted 2,820 enforcement actions. In 2012-2013, they identified $46 million in additional taxes owing. Source: Annual Report to Parliament 2011-2012 - CRA page 32; Annual Report to Parliament 2012-2013 - CRA page 50
  
  
• 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 used to have 2007 publication RC4444, Making a Difference for Canadians, that explained their approach to tax administration, how they deter non-compliance and enforce legislation. However, since they have restructured their website, it seems to have gone by the wayside ... which is too bad.

So what is CRA's approach to tax administration? The publication stated that "our fundamental approach to tax administration is to enable individuals and businesses to comply with their obligations, without our direct intervention." As taxpayer non-compliance increases, so does CRA involvement.

They deter non-compliance by conducting reviews and audits. 

CRA's current 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.

In 2014, CRA has proposed registration of tax preparers (the U.S. already has this already) so they can identify and help those submitting recurring errors when preparing small business returns. 

Simple Tax Compliance Method

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 theenvelope.

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.

Benefits of Good Bookkeeping Practices

Earlier I laid out what I think 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.

CRA and The Underground Economy

The CBC reports that in 2014, CRA will be auditing waiters/waitresses, sub-contractors and freelancers looking for unclaimed income. On their radar are:

✔ tips

✔ selling used cars on Craigslist

✔ day labor on construction sites

✔ home renovations subcontracted by the retail stores

✔ flipping houses

✔ driving trucks and hot shot couriers

✔ freelance articles income

“You participate in the underground economy when you fail to declare income that would generally be taxable if you reported it to the tax authorities" (Definitely not good bookkeeping! I might even go so far as to say this would definitely be an example of very bad bookkeeping practices.) ...

"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.”

In September 2012, Stats Can released their study of the underground economy for the years 1992 - 2009. The three most significant industries with underground activity were construction, retail trade, and accommodation and food services; accounting for 61% of the total estimate.

The information from the study will be used by CRA to further develop compliance strategies for the underground economy. See CRA newsroom> Fact Sheets> 2012> Statistics Canada Study on the Underground Economy in Canada for more information.

During the 2010-2011 reporting period, CRA performed 834 underground economy audits, resulting in $87 million taxes owing. (see source note below) 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.

Dealing in cash thrives in the underground economy. Here is a bookkeeper's tip about cash and GST/HST. GST/HST must still be collected by registrants on cash sales. This also means that you need a receipt for expenses paid by cash if you want to claim your input tax credit.

Source: CRA website> About the CRA> Tax Alert> Special enforcement audits

---

Cash Myth
From the CRA Website

“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 topractice good bookkeeping and keep an honest set of books ... with the added benefit that you sleep better at night.

---

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.

If you are suspected of tax avoidance, CRA may challenge some of your business transactions. If the suspected transactions were made solely to avoid tax and were not legitimate business transactions, the CRA can ignore them. Interest on unpaid tax balances will be assessed but no penalties will be charged.

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.

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.

Let's have tea ... and chat about each one of the six good bookkeeping practice categories on the coming pages.

Bookkeeping Essentials › Small Business Accounting › Good Bookkeeping Practices