Properly accounting for your business activities can be just as confusing as it is important. The financial statements that you provide to us each year serve as our map to completing your business tax returns. Read on for tips on what to look out for in preparing financial statements to help us streamline the preparation of your returns.
The financials provided for your business are our starting point and main resource in the preparation of your business tax returns. Accurate, detailed financial statements will result in a more accurate and efficiently produced tax return. Below are some common pitfalls we find on business financials and how to avoid them.
Not Enough Accounts
The income and expenses on your profit and loss statement should be broken out into clearly labeled accounts.
Pitfall: Having one generic account such as “Business Expenses” which contains several different types of expenses including taxes, insurance, rents, repairs, supplies, and reimbursements.
Improvement: Create separate accounts for each different type of expense, similar those listed above, for a better overall picture of your business.
Too Many Accounts
On the other hand, creating too many accounts can lead to overly-complicated financials. It will be more difficult for you to understand how your business is doing and will take us more time to organize your accounts for tax return purposes.
Pitfall: A business with multiple business activities or locations may be tempted to create individual accounts for each activity and each type of income or expense.
Improvement: Try using the classification field in your accounting software to specify which business activity each income or expense item is related to. For example, repairs from activities A and B will both be recorded to the same ‘Repairs’ account. Simply include “Activity A” or “Activity B” in the classification field. This will allow you to produce clear financial statements while maintaining the ability to run reports showing the detail of either activity.
One of the most common analyses we do when preparing your business tax return is determining whether a purchase should be capitalized or expensed. If there are material transactions on your financials for items such as supplies, furniture, equipment, or payments for repairs, it is likely that more information will be needed. This most commonly applies to transactions over the $2,500 de minimis expensing safe harbor.
Pitfall: Recording a transaction over $2,500 with the memo ‘Supplies/Equipment’ or no memo at all.
Improvement: In your memo, include specific details regarding the type of equipment purchased, purpose of any repairs, and whether the transaction was for multiple items below the capitalization threshold. Proactively providing these details can prevent unnecessary follow-up questions, saving time for everyone.
Meals & Entertainment
The recent tax reform act included a number of changes to the deductibility of expenses for meals and entertainment. Updating your financials to include classifications for each of these expenses will enable us to properly calculate your deduction.
Pitfall: Recording transactions to a singular “Meals & Entertainment” account without a memo or classification.
Improvement: Begin using the following classifications for these expenses: Office Parties, Client Entertainment, Client Meals, Employee Entertainment, Employee Meals, and Employer Convenience.
For more information on how to determine the proper classification and tax implications of meals and entertainment please see our past article which can be found here.
It is important to confirm that your financial statements accurately reflect all assets and activity by preparing a reconciliation of your bank accounts.
Pitfall: Waiting until the end of the year to reconcile your accounts and having to search for any discrepancies throughout a year’s worth of activity.
Improvement: Reconcile your cash accounts to the bank statements at the close of each month to ensure that any mistakes are caught and corrected.
Accounting for your business activities can be complicated but avoiding these common pitfalls is a great start to creating accurate and informative financial statements. This will help ensure the smooth preparation of your returns, and will leave you with more reliable records of your business activities. If you are considering implementing any of the above methodologies, please contact your L&B professional at 858-558-9200.