All debits and credits either increase or decrease an account balance. These basic relationships are summarized in the chart below:

Account Type	Debit	Credit
Asset	Increases	Decreases
Liability	Decreases	Increases
Stockholder’s Equity	Decreases	Increases
Income	Decreases	Increases
Expense	Increases	Decreases

In a general ledger, debits always go on the left and credits always go on the right. (For examples of general ledger debit-and-credit entries, see the chart on page 649).

While many double entries are made directly to the general ledger, you’ll find it’s necessary to maintain subledgers for a number of accounts in which there is regular activity. The information is then taken in a summary format from the subledgers and transferred to the general ledger. Subledgers showing cash receipts and cash disbursements are pretty easy to follow. However, some subledgers, such as accounts receivable, inventory, fixed assets, accounts payable and payroll can prove to be a challenge in their daily maintenance.

GENERAL LEDGER ENTRIES

While the bookkeeping process for your business can be rather intricate, single debit and credit entries are really quite basic. Remember that for every entry, there is an equal and offsetting co-entry. Also keep in mind that the different types of accounts have both debits and credits depending on whether the account is increased or decreased (see the chart above). Here are five examples of equal and offsetting general ledger entries for a sock manufacturing business:

1.	Purchasing a delivery truck	Debit	Credit
	Cash (Asset)		$20,000
	Fixed Asset (Asset)	$20,000
2.	Purchasing yarn on account to make the socks
	Accounts Payable (Liability)	$25,000
	Inventory (Asset)		$25,000
3.	Selling a sock order to a customer on account
	Accounts Receivable (Asset)	$10,000
	Sales (Income)		$10,000
4.	Collecting the account receivable from the same customer
	Accounts Receivable (Asset)		$10,000
	Cash (Asset)	$10,000
5.	Funding payroll at the end of the month
	Payroll Expense (Expense)	$20,000
	Cash (Asset)		$20,000

Accounts Receivable

If you plan to sell goods or services on account in your business, you will need a method of tracking who owes you how much and when it is due. This is where the accounts receivable subledger comes in. If you will be selling to a number of different customers, then an automated system is a must.

AHA!

If you’ll be selling on credit, your accounts receivable system will be vital. Here are five key components of a good accounts receivable system: 1. Verify accounts receivable balances. Use source documents such as invoices to keep balances accurate. 2. Send accurate and timely invoices. 3. Generate accounts receivable reports. Determine which customers are past due and track credit limits. 4. Post paid invoices to track who pays you when. 5. Match up your customer records totals, your general ledger and subledgers.

A good bookkeeping software system will allow you to set up subledgers for each customer. So when a sale is made on account, you can track it specifically to the customer. This is essential to ensure that billing and collection are done in a timely manner.

Inventory

Unless you are starting a service business, a good inventory-control feature will be an essential part of your bookkeeping system. If you are going to be manufacturing products, you will have to track raw materials, work-in-progress and finished goods, and separate subledgers should be established for each of these inventory categories. Even if you are a wholesaler or a retailer, you will be selling many types of inventory and will need an effective system to track each item offered for sale.

Another key reason to track inventory very closely is the direct relationship to cost of goods sold. Since nearly all businesses that stock inventory are required to use the accrual method for accounting, good inventory records are a must for accurately tracking the material cost associated with each item sold.

From a management standpoint, tracking inventory is also important. An effective and up-to-date inventory-control system will provide you with the following critical information:

• Which items sell well and which items are slow-moving

• When to order more raw materials or other items

• Where the inventory is stored when it comes time to ship

• Number of days in the production process for each item

• The typical order of key customers

• Minimum inventory level needed to meet daily orders

(For more information on inventory-control systems, see Chapter 19.)

Fixed Assets

Fixed assets are items that are for long-term use, generally five years or more. They’re not bought and sold in the normal course of business operation. Fixed assets include vehicles, land, buildings, leasehold improvements, machinery and equipment.

In an accrual system of accounting, fixed assets aren’t fully expensed when they are purchased but rather they are expensed over a period of time that coincides with the useful life (the amount of time the asset is expected to last) of the item. This process is known as depreciation. Most businesses that own fixed assets keep subledgers for each asset category as well as for each depreciation schedule.

SAVE

For more information on setting up your bookkeeping system, you can download Starting a Business and Keeping Records (Publication 583) for free from the IRS website at irs.gov.

In most cases, depreciation is easy to compute. The cost of the asset is divided by its useful life. For instance, a $60,000 piece of equipment with a five-year useful life would be depreciated at a rate of $12,000 per year. This is known as straight-line depreciation.

There are other more complicated methods of fixed-asset depreciation that allow for accelerated depreciation on the front end, which is advantageous from a tax standpoint. You should seek the advice of your CPA before setting up depreciation schedules for fixed-asset purchases.

Accounts Payable

The accounts payable subledger is similar to that used to track accounts receivable. The difference is, accounts payable occur when you purchase inventory or other assets on credit from a supplier rather than tracking a specific sale to a customer.

It is important to track accounts payable in a timely manner to ensure that you know how much you owe each supplier and when payment is due. Many a good supplier relationship has been damaged due to a sloppy accounts payable system. Also, if your suppliers offer discounts for payment within ten days of invoice, a good automated accounts payable system will alert you when to pay to maximize the discounts earned.

Payroll

Payroll accounting can be quite a challenge for the new business owner. There are many federal and state laws regulating what you have to track related to payroll (see Chapter 41). Failure to do so could result in heavy fines—or worse.

WARNING

All businesses are subject to laws governing the payment of federal and state withholding taxes. Here are three rules that must never be violated in your business: 1. Make sure you have current withholding tax tables. 2. Always make your payroll deposits on time. 3. Stay up-to-date and accurate with payroll record-keeping reporting requirements.

Many business owners use outside payroll services. These companies guarantee compliance with all the applicable laws. This keeps the business owner out of trouble with the law and saves time that can be devoted to something else in the business. If you choose to do your own payroll, it’s recommended that you purchase an automated payroll system. Even if the rest of your books are done manually, an automated payroll system will save you time and help considerably with compliance. There’s not a lot of margin for error when you’re dealing with the federal government!

Cost Accounting

Cost accounting is the process of allocating all costs associated with generating a sale, both direct and indirect. Direct costs include materials, direct labor (the total wages paid to the workers who made the product), foreman/plant manager salaries and freight. Indirect costs include all other costs associated with keeping your doors open.

As profit margins have shrunk in many businesses, particularly manufacturing ventures, cost accounting has become an increasingly valuable tool. By knowing the total costs associated with the production of a product, you can determine which inventory items are the most profitable to make. This will enable you to focus your sales efforts on those inventory items rather than on products that offer little or no bottom-line enhancement.

To set up an effective cost accounting system, you should seek input from your CPA. Cost accounting can get fairly complicated, and the money you might spend for a CPA will be more than made up for in the expertise he or she will provide in customizing a cost accounting system for your business.

Under Control

Do you know any business owners who have suffered significant losses due to employee theft or embezzlement? They probably did not have an effective internal-control system in place. Many successful ventures have been set back or even put out of business by an unscrupulous employee or financial service provider. And it is often someone whom the business owner least suspected of wrongdoing.

When setting up a bookkeeping system, you need to focus a good deal of effort on instituting a sound system of policies and procedures governing internal control. Here are ten areas where you need internal control:

1. You need a written policy that clearly spells out your internal-control system . Make sure all employees read this policy. Having a policy not only spells out the procedures to be followed, but it also lets your employees know you are serious about internal controls.

2. On a regular basis, review the internal-control policy to ensure it is up-to-date. When changes are made, hold meetings with employees to discuss the changes and to maintain a focus on this vital area.

3. Make sure all employees take at least one week of vacation each year. This is often the time during which embezzlement is discovered.

4. Cross-train others in the company to handle bookkeeping. If the person who is stealing from you is sick or on vacation, you’ll have a hard time catching him if you let the work go unprocessed until his or her return.

5. Perform background checks before hiring new employees. This may sound obvious, but dishonest employees often are hired by unsuspecting employers who failed to check references before making the offer.

6. Use dual control. You’re asking for trouble if you have the same person running the accounts payable system, making journal entries, printing and signing checks, and reconciling the checkbook.

7. Have your CPA or outside bookkeeper perform unannounced spot audits. You may be uncomfortable performing these audits yourself, but if your policy calls for periodic audits, the CPA looks like the bad guy.

8. Be careful who you hire as an outside financial services provider. There are countless stories of entrepreneurs being ripped off by supposedly trusted professional service providers such as accountants and attorneys. Don’t relinquish total control of your cash to an outside bookkeeper. And if he or she seems reluctant to share information with you when you ask for it, this could be a sign of deceptive financial advisory practices.

9. Back up your computer information regularly. This is an important function for all aspects of your business. If you begin to suspect an employee of stealing, the ability to study past transactions will be vital in finding out if your suspicions are justified.

10. In the early stages of your business, you may be able to monitor much of the cashcontrol procedures yourself. However, as your business grows, you will be forced to delegate certain internal-control functions. When you do, make sure you choose qualified, welltrained employees who have proved to be trustworthy. And make sure your policy clearly stipulates the person who is authorized to perform internal-control tasks such as processing invoices and signing checks.

SAVE

Following are three tips for your accounts payable system that will improve your business’s cash flow: 1. Take discounts whenever feasible. Saving 1 or 2 percent on an order can be significant. 2. If discounts aren’t offered, don’t pay early. There’s no need to drain your cash flow unnecessarily. 3. Keep your suppliers informed. If you do fall behind, keep the lines of communication open with your suppliers. You can ill afford to get put on c.o.d.

Financial Statements

One of the primary benefits of a good bookkeeping system is the generation of timely and useful financial statements. Most automated software packages offer the capability of producing monthly financial statements. This information includes a balance sheet, an income statement and a cash-flow statement. These monthly reports provide invaluable information on the historical measures you need to make the financial decisions that will positively impact your business tomorrow.

Refer to the next chapter for a look at these financial statements in detail and how you can use them for effective short- and long-term financial planning.

IT ALL ADDS UP

In the not-too-distant past, to set up an automated bookkeeping system you had to spend countless hours yourself or hire a programmer to customize an accounting system for your business. And since most new business owners did not have the time to do it themselves or the financial resources to hire a programmer, cumbersome manual systems were used, or the bookkeeping function was completely outsourced to an accountant or bookkeeping service.

Fortunately, those days are over. In today’s market, new business owners will find a number of very affordable and full-featured accounting software packages from which to choose. These popular accounting packages not only allow business owners to track and manage every aspect of their companies’ finances, but they also reduce accounting expenses by saving accounting firms time and effort in producing companies’ year-end tax return and/or financial statements.

Here are some of the most popular “canned” accounting software packages: Intuit’s QuickBooks Pro, Peachtree’s Complete Accounting, and Sage’s Simply Accounting. They range in price from $50 to $299. Regardless of which package you buy, it will be one of the most beneficial purchases you make in starting your small business.

For the Record

As you set up your bookkeeping system, you will need to establish procedures for keeping financial records. The IRS requires that you keep records on hand for certain specified periods of time. And with some financial records, it just makes good business sense to keep them so you can access them at a later date.

One key point here is to make sure these records are kept in a safe place. Whether you store them on-site or at a remote location (some business owners use self-storage units), make sure you use a fireproof cabinet or safe.

Another recommendation is to minimize paper buildup by storing as much as possible on CDs, microfilm or DVDs. Here is a list of what you need to save and for how long, as recommended by accounting firm PricewaterhouseCoopers:

Record Type	How Long?
Income tax reports, protests, court briefs, appeals	Indefinitely
Annual financial statements	Indefinitely
Monthly financial statements	3 years
Books of account, such as the general ledger	Indefinitely
Subledgers	3 years
Canceled payroll and dividend checks	6 years
Income tax payment checks	Indefinitely
Bank reconciliations, voided checks, check stubs and register tapes	6 years
Sales records such as invoices, monthly statements, remittance advisories, shipping papers, bills of lading and customers’ purchase orders	6 years
Purchase records, including purchase orders and payment vouchers	6 years
Travel and entertainment records, including account books, diaries and expense statements and receipts	6 years
Documents substantiating fixed-asset additions, depreciation policies and salvage values assigned to assets	Indefinitely
Personnel and payroll records, such as payments and reports to taxing authorities, including federal income tax withholding, FICA contributions, unemployment taxes and workers’ compensation insurance	6 years
Corporate documents, including certificates of incorporation, corporate charter, constitution and bylaws, deeds and easements, stock, stock transfer records, minutes of board of directors meetings, retirement and pension records, labor contracts, and license, patent, trademark and registration applications	Indefinitely

The Bookkeeping Advantage

Basic Accounting Principles

Accounting System Components

Chart of Accounts

General Ledger