Doing your accounting isn't about being compliant so you don't get in trouble. It's about taking control of your business so you have the power to influence its growth.
Joey Cowan, Lead Accounting Coach, Wave+
Step 1: Catch Up on Your Bookkeeping
The first thing you need to do to prepare for tax time is get your bookkeeping in order. Gather your receipts and bills from purchases you’ve made during the tax year, as well as your customer invoices and bank account statements.
Update your expense records
First, pay off any outstanding bills. Make note of any expenses you’ve used, but haven’t been charged for yet, like phone, gas and electricity bills, and also any expenses you’ve pre-paid but haven’t yet used, like insurance and rent.
Don’t forget to include any personal expenses you also use for your business. Divide the total cost based on business and personal use.
Update your income records
Check for billable sales or services you haven’t invoiced for yet and send those out. Follow up on any outstanding invoices, and send final reminders to late customers.
Make note of any customer deposits you’ve received for work you haven’t done yet, as well as work you’ve started but can’t invoice for yet.
If you’re using accounting software, make sure you’ve properly categorized and verified all your income and expenses, and that taxes are accounted for within each transaction.
Reconcile your accounts
Make sure all of the transactions in your bank statements appear in your accounting records without duplicates.
Run your final payroll
Complete your payroll and remind your employees to submit any expense reimbursement before the period ends.
Step 2: Make Year-End Period Adjustments
Time to tackle year-end period adjustments. These are journal entries made to your business accounts at the end of a period so your financial statements accurately reflect your business performance.
If you buy inventory and then resell it, it’s a COGS expense. If you buy inventory and don’t sell it, it’s an asset.
At the end of the year, you’ll want to know how much of that inventory actually represents expenses or assets. Then you or your bookkeeper may need to make some adjustments based on reality, in the form of journal transactions, in your accounting software or records.
Bad debt adjustments
If you’ve followed up with a client but it looks like you’re never going to get paid, write off those invoices to ensure accuracy.
Reconciling loan accounts
If you’ve taken out a loan and you’re making payments throughout the year, those payments will either be principal repayment or interest. At year end, make adjustments to reflect the actual amount you paid back in capital and how much was interest.
The assets you purchase are recorded at cost, but they depreciate over time.
You’ll need to record your assets’ depreciation monthly, quarterly or annually. You can use a few different methods to reconcile it, including fixed percentage, straight line, and reducing balance methods. Your accountant may recommend the best approach for your business.
Record deposits you’ve received for work not done yet as credits to a liability account for deposits, and a debit to your cash account. It’s a liability because you have an obligation to fulfill the work.
When you eventually ship the customer order or complete the contracted work, enter a reverse journal transaction debiting the deposit account, and crediting the relevant account.
Let’s go back to the unused, prepaid expenses from step one. Record those payments as a debit to an asset account for prepaid expenses, and a credit to your cash account. When you use the prepaid expense, you’ll enter a reverse journal transaction debiting the relevant expense account, and crediting the prepaid expense account.
Recognizing accrued revenue
Accrued revenue is work you’ve done, but you haven’t invoiced for yet. You’ll record an accrual as a debit in an asset account for accrued sales, and a credit to services. Once you invoice for the work, don’t forget to record an entry to reverse the initial accrual.
Recognizing accrued expenses
Accrued liabilities reflect expenses incurred this year but won’t be billed until next fiscal year. You’ll record an accrual as a credit in a liability account for accrued expenses, and a debit to income statement expense account. Once you receive the bill, don’t forget to record the entry to reverse the initial accrual.
Step 3: Convert Accrual to Cash If You File on a Cash Basis
There are two standard ways you can do your accounting: accrual-based and cash-based. Accrual-based means you recognize expenses and income when they are incurred. Cash-based recognizes them once they’re paid.
Many accounting systems use the accrual method, but some small businesses file tax returns using cash-based accounting. If that’s you, you need to convert your accounting reports from accrual to cash.
Converting to cash from accrual
First, find your Accounts Receivable (AR) and Accounts Payable (AP) opening and closing balances through your balance sheet. Then run your income statement from start date to the last date of the year and record your total revenue from sales and total expenses. You can use this worksheet to help you.
Step 4: Send Your Records to Your Accountant
The final step is to pass your books along to your accountant. Make sure you share the following reports with your accountant:
- Period matching adjustments
- Trial balance
- Balance sheet
- General ledger
Now you’ve got a complete set of accounts for the year — you’re in a great position to review your business performance, and make strategic decisions to help your business be more profitable and grow.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.