Guide to Accounting Records
We hope our Guide to accounting record keeping will assist you - click on a link to read more information on that subject:
- Why are records required?
- What accounting records must I keep?
- Cash Accounting for VAT
- Accounting Software – General or Nominal Ledger
- Accounting Software - Customer and Supplier Ledgers
- What are annual accounts and how are they prepared?
1. Why are records required?
The Inland Revenue impose an obligation to keep records for the purposes of delivering a correct and complete tax return.
Records of the transactions are necessary to enable accounts to be prepared which measure the profit or loss of the business. A taxpayer has an obligation to return the profit to the Revenue and be taxed upon it. Without records the accounts cannot be prepared and the profit cannot be satisfactorily established.
There are severe penalties for the failure to maintain proper records but there is a real annual cost from the additional expense and delays in accounts completion arising from poorly kept and inadequate records.
The taxing acts impose a duty upon an Inspector of Taxes to assess profits to tax to the best of his ability. Nothing more. That gives the inspector the right to refuse to accept accounts and tax returns where he is not satisfied that they properly reflect the profits earned and in such circumstances he may impose his own view of what profits have actually been earned and what tax is payable.
Typically, if he can demonstrate that there are inconsistencies or omissions in the records then that gives him the right to do so. (A process known as 'breaking the records’).
If the inspector can demonstrate that the records are unreliable he is empowered to go back at least six years and review all tax returns and accounts. If he is not satisfied he may raise assessments for such sums as he thinks fit and in respect of which penalties of up to 100% of the tax due may be imposed together with interest. Where criminality has taken place, say for example where there have not only been omissions but deliberate falsification of the records, then the Revenue may go back 20 years. Such investigations are relatively uncommon, but far from unknown. They can be hugely wearing upon the taxpayer concerned and expensive in accountancy fees incurred in resolving matters.
The inspector is also entitled to ask for evidence of expenditure. If that evidence cannot be produced then he is entitled to disallow the deduction with the result that no tax relief is obtained upon it. That is why receipts and suppliers’ invoices are vital, quite apart from their obvious use in the accounts preparation exercise.
If reclaiming input VAT on expenditures, again evidence is required in the form of a VAT invoice. No evidence – no reclaim permitted.
Finally, we are professionally obliged to carry out a certain amount of validation of your records and typically we will vouch (check) a sample of your recorded expenditures to your suppliers invoices.
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2. What accounting records must I keep?
The legislation does not specify the records you must maintain this - it is simply a matter of judgement.
The style of the records to keep will be dictated by the nature of your activities. The record-keeping requirements of a shop are very different from those of a joiner.
The essential records for small businesses are of :-
- All work done or sales made - (sales day book)
- All sums received - (cashbook)
- All sums lodged at the bank - (cashbook)
- All sums paid out together with an indication of what each was for and how it was paid e.g. from the bank account or in cash (cashbook) or by credit card.
In addition, if the trader is VAT registered then he must maintain a VAT account which itself consists of the records necessary for proper completion of his VAT return. It is important to note however that for conventional VAT accounting, records of sums paid out are not adequate and a record must also be maintained of all suppliers’ invoices received (purchase day book). But see below for cash accounting for VAT.
The proprietary accounts books available in the shops are invariably written for retailers. They are too often poorly designed, can be wearisome to use and are not recommended. Furthermore they are usually all but useless for trades other than shops.
While there is no substitute for having layouts designed specifically for your activity, we have established a number of layouts that have been found to be commonly satisfactory for a variety of activities.
Some narrative of what payments are actually for, as well as to whom they are made, is of at least of equal importance. Column headings such as ‘Motor Vehicle Expenses’, ‘Insurances’ and suchlike with no description of the expenses listed require our accounting staff to locate the underlying invoice to identify the item - time consuming and costly. Far better that a brief descriptive narrative is entered alongside e.g. ‘van service’, ‘public liability insurance’.
It is also very helpful if the payments made are distinguished by the manner of the payment. Thus payments made from the bank account should be in a separate column from those paid out in cash and from those paid by credit card. A failure to distinguish again causes time to be wasted in the accounts preparation exercise.
A cash business is just that -- a cash business, and there is no obligation to raise any paperwork in respect of sales made. A customer may request a receipt in a shop and a shopkeeper may choose to give him one but there is no obligation to document it -- only an obligation to record the sum of money received. Such a business is expected to maintain a balanced cashbook, by which we mean a weekly record of sums received, paid out and lodged at the bank, which balances to the opening and closing cash floats.
On the other hand a business selling goods or services on credit will be expected to raise an invoice for each sale made or work done and to retain a copy of that invoice. A record of the invoices raised must then be kept in a sales daybook. A column in the sales daybook to record the date that the invoice was paid enables you to quickly see which invoices to your customers are overdue and exercise appropriate credit control measures.
It is important to note that profits are measured by reference to the value of work carried out or goods sold in a period (the ‘accruals basis’). It does not matter that those goods or services have not yet been paid for. All work done or sales made in a period must be reflected in the profits of the business. From which it follows that for businesses providing credit to their customers it is compulsory to maintain records of all sales made as a well as a record of all sums received -- they are not the same thing.
If a business maintains a petty cash box for small out-of-pocket expenditures then it is usual to maintain a record balanced to the contents of the box (the imprest system).
It should be noted that the conventional basis of accounting for VAT requires that input tax (charged by suppliers) and output tax (charged to customers) be accounted for to Customs in the quarter in which the supply is made -- not when it is paid for.
Hence the need to maintain sales and purchase daybook records of sales and suppliers’ invoices in order to complete properly the VAT returns.
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3. Cash Accounting for VAT
This option enables you to only account for VAT on the basis of sums actually received.
It is hyped as being a great help to small businesses but in reality it is only of significant benefit in a very few cases. More often the accounting problems associated with it commonly outweigh any advantage.
The advantage is a one-off improvement in your bank balance: the VAT content of your customer debts lying out less the VAT content of your unpaid suppliers bills remains in your bank account instead of H M Treasury.
The disadvantages are that it complicates your VAT accounting endlessly and is a constant source of errors. The errors are then typically discovered either during the accounts preparation process or by a visiting VAT inspector. Furthermore, cash accounting is in conflict with the ‘accruals’ concept of accounting referred to above with the result that fiddly adjustments have to be made during the accounts preparation exercise to accommodate it. It all adds up to additional work.
As a result we normally recommend that it only be used by those with desperate financing issues.
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4. Accounting software – General or Nominal Ledger
Integrated accounting software packages are ordinarily written around the double-entry bookkeeping system.
Unless an individual has been trained in double-entry bookkeeping then it is most unlikely that they can satisfactorily maintain the general ledger. The resulting output is often so poor that it is unusable, or requires so much work to correct it that it would be cheaper to prepare the accounts by reference to the prime records (by prime records we mean bank statements, cheque book stubs, pay in books, sales day book or copies of sales invoices, purchase day book and suppliers invoices and statements). In some cases the insurmountable deficiencies only become apparent well into the accounts preparation exercise, resulting in aborted work and inevitably increased costs.
Keeping a general ledger is not necessary for most small businesses, it adds nothing of value and only occasionally saves anything in accountant's fees; simple records maintained by hand or on a PC consisting of work done or sales made, sums received and paid out are normally quite adequate. However maintaining the customer and supplier records in a software package can be very helpful. See below.
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5. Accounting Software - Customer and Supplier Ledgers
There are accounting software applications however that can be extremely helpful even to small businesses: the customer (sales) and suppliers (purchases) ledger.
The sales ledger allocates invoices raised to the customers account, records sums received from the customers and enables monthly statements on account to be printed and despatched. It also provides monthly prints of overdue debts to help with credit control.
On the supplier side it provides a record of invoices received from each supplier, when they were paid, and what is outstanding.
Finally, the software produces VAT records from which to prepare VAT returns.
Little double-entry bookkeeping knowledge is required and most conscientious individuals can maintain such ledgers relatively well.
As a result they are often a genuine advantage to the business concerned.
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6. What are annual accounts and how are they prepared?
Ordinarily they consist of two components: a profit and loss account, which measures the profit or loss earned or incurred during the accounting period, and a balance sheet, which is a statement of affairs at the closing date of the accounting period; a snap-shot if you like of how matters stood on that day, consisting of a list of assets and liabilities e.g. equipment, stocks, sums owed to and by you, balances on cash and bank accounts, loan & finance accounts and credit cards etc; the whole summarising the book value of the net assets in the business at that time.
They are prepared from the books and records (including VAT records), all tied in together i.e. reconciled one to another, to result in a measure of profits (earnings) for the year. Reconciling your accounts to your VAT records ensures consistency between your tax and VAT returns and enables errors to be identified and corrected, thereby minimising the risk from H M Revenue & Customs enquiries into your affairs.
For very small accounts we may dispense with the balance sheet and only measure the profit. However, preparation of a balance sheet gives a better assurance that the profit measured will be fairly stated.
We employ a number of techniques to reconcile the various elements of your records and in doing so errors and deficiencies are often identified which we then bring to your attention. And having prepared your accounts if we have any suggestions to make as regards your record keeping we will do so.