Accounting/bookkeeping question
October 20, 2013 2:59 PM Subscribe
With the help of an accountant, I'm trying to teach myself bookkeeping for our small business. Our business is set up so that we collect *x-amount* when a client reserves our services, then *x-amount* six months before we provide the service, then finally, *x-amount* 30 days before we provide the service. Our accountant is advising us to accept these amounts as prepayments and not generate an invoice until we've received final payment. Basically, even though this money is going into our bank account, it's not showing as income on our income statement until we've received final payment/generated the invoice. Is this the best way to do this?
In the past, I have accepted payments as income once I've received them. Taxes paid to the state were dispersed more evenly throughout the year because we did it this way (our business is fairly seasonal). I want to begin bookkeeping "the right way," but it seems like this way will be pretty confusing, at least in the beginning. If our contract states that all deposits and payments are non-refundable, is there any reason why we can't generate an invoice / accept payment as income once they've made the initial payment?
Also, if it matters, I'm using xero as software.
In the past, I have accepted payments as income once I've received them. Taxes paid to the state were dispersed more evenly throughout the year because we did it this way (our business is fairly seasonal). I want to begin bookkeeping "the right way," but it seems like this way will be pretty confusing, at least in the beginning. If our contract states that all deposits and payments are non-refundable, is there any reason why we can't generate an invoice / accept payment as income once they've made the initial payment?
Also, if it matters, I'm using xero as software.
The terms you are looking for are cash-based accounting (what you did) and accrual accounting (what your accountant wants). In cash-based, you follow the money (no accounts payable or accounts receivable). In accrual, you follow when the work was done.
There are some ways in which you can accrue income as work is being done, or on things like registration. But your accountant would know more about whether or not this is valid for your specific business.
For small businesses, I believe cash-based accounting is still legal in the US for taxation purposes, so in that sense (if I am correct, and if your business is a small business) your accountant is wrong. There are good reasons to switch to accrual accounting in general, but I cannot speak to your specific situation. You should look into these terms and ask your accountant more specific and relevant questions.
posted by jeather at 3:44 PM on October 20, 2013 [2 favorites]
There are some ways in which you can accrue income as work is being done, or on things like registration. But your accountant would know more about whether or not this is valid for your specific business.
For small businesses, I believe cash-based accounting is still legal in the US for taxation purposes, so in that sense (if I am correct, and if your business is a small business) your accountant is wrong. There are good reasons to switch to accrual accounting in general, but I cannot speak to your specific situation. You should look into these terms and ask your accountant more specific and relevant questions.
posted by jeather at 3:44 PM on October 20, 2013 [2 favorites]
Your client is *pre*-paying you for something the client hasn't yet received -- you still owe the client your good/service. So if you count the money from the client *and* the good/service you haven't yet given the client as *all* being yours, you're overstating what's yours. Vice versa: if you've already given a client a good/service, and so you don't count it, and they haven't given you money yet so you don't count that, then you're understating what's yours.
The point of accrual accounting (as opposed to cash accounting) is that it counts what you owe and what's owed to you and not just what you have and don't have. So if clients are giving you money in advance of your good/service and/or you're giving clients a good/service in advance of getting their money, it makes sense to use accrual accounting because it can get your books to accurately reflect what you're waiting to give/receive in a way that cash based accounting can't.
So for what it's worth, I agree with your accountant that accrual accounting is the way to go.
*Grain of salt: I've taken a couple accounting classes but am light years away from being an accountant.
posted by rue72 at 4:26 PM on October 20, 2013
The point of accrual accounting (as opposed to cash accounting) is that it counts what you owe and what's owed to you and not just what you have and don't have. So if clients are giving you money in advance of your good/service and/or you're giving clients a good/service in advance of getting their money, it makes sense to use accrual accounting because it can get your books to accurately reflect what you're waiting to give/receive in a way that cash based accounting can't.
So for what it's worth, I agree with your accountant that accrual accounting is the way to go.
*Grain of salt: I've taken a couple accounting classes but am light years away from being an accountant.
posted by rue72 at 4:26 PM on October 20, 2013
Response by poster: Thanks for the very helpful responses so far. My accountant chose "cash basis" in the financial settings of xero.
"So if clients are giving you money in advance of your good/service and/or you're giving clients a good/service in advance of getting their money, it makes sense to use accrual accounting"
We never provide service in advance of getting money.
posted by okay-quiet-time at 4:56 PM on October 20, 2013
"So if clients are giving you money in advance of your good/service and/or you're giving clients a good/service in advance of getting their money, it makes sense to use accrual accounting"
We never provide service in advance of getting money.
posted by okay-quiet-time at 4:56 PM on October 20, 2013
What country are you in? And what industry? I ask because I've done small business accounting and this is the first I've heard of Xero, which is interesting, and it seems to have been created outside the US, and it made me think--most of my clients are set up as 'cash basis' but the reality is that we're actually doing them on tax basis? Which is to say, it's a modified form of cash basis and occasionally there are things that aren't strictly the same. But overall, this is pretty much what accrual IS, so. But certain small businesses do not have to report on the accrual basis and take more time/effort to do the accruals than they'll see in benefits, so the number of businesses I've handled on accrual--well, pretty small.
But your mileage is going to vary significantly if you aren't in the US and subject to US tax and reporting laws.
At the very least: You are always, always, always entitled to ask your accountant to explain the reasoning behind changes like this, especially if it's going to increase your workload or increase the amount you pay in taxes.
posted by Sequence at 5:30 PM on October 20, 2013
But your mileage is going to vary significantly if you aren't in the US and subject to US tax and reporting laws.
At the very least: You are always, always, always entitled to ask your accountant to explain the reasoning behind changes like this, especially if it's going to increase your workload or increase the amount you pay in taxes.
posted by Sequence at 5:30 PM on October 20, 2013
Response by poster: In the US and operate a wedding/event venue.
posted by okay-quiet-time at 5:47 PM on October 20, 2013
posted by okay-quiet-time at 5:47 PM on October 20, 2013
If you are using cash-basis, you should not be waiting until you have provided the service to bring it into income. That's the definition of accrual accounting.
There is something here that doesn't make sense. Are you currently using cash basis and your accountant wants you to switch? If your accounting software is set up to use cash basis, what do you do with the money you get in as deposits? Just ignore it until you finally provide the service? If so, how do you reconcile your accounts? Or does it show up as something like unearned revenue? In that case, you're set up to use accrual accounting.
Note: you're legally allowed, in some cases, to keep two sets of books, one on cash basis and one on accrual to use the first for taxes and the second to get a better picture of your financial situation.
posted by jeather at 5:51 PM on October 20, 2013 [1 favorite]
There is something here that doesn't make sense. Are you currently using cash basis and your accountant wants you to switch? If your accounting software is set up to use cash basis, what do you do with the money you get in as deposits? Just ignore it until you finally provide the service? If so, how do you reconcile your accounts? Or does it show up as something like unearned revenue? In that case, you're set up to use accrual accounting.
Note: you're legally allowed, in some cases, to keep two sets of books, one on cash basis and one on accrual to use the first for taxes and the second to get a better picture of your financial situation.
posted by jeather at 5:51 PM on October 20, 2013 [1 favorite]
Response by poster: Accounting lingo is still really new to me, but basically, she wants me to reconcile these payments under the account "customer deposits" until I've received final payment. At this time, I would create an invoice and apply the prepayments to the invoice.
The reason I'm so hesitant to make this switch-over is because I've already accepted partial payments from several clients and have declared these payments as income for state tax purposes.
posted by okay-quiet-time at 6:07 PM on October 20, 2013
The reason I'm so hesitant to make this switch-over is because I've already accepted partial payments from several clients and have declared these payments as income for state tax purposes.
posted by okay-quiet-time at 6:07 PM on October 20, 2013
Then she wants you to switch from cash basis to accrual basis. Accrual basis has a lot of major advantages in general, but not necessarily for you. Ask her why she wants you to switch over, ask her what to do about partial payments. I don't know what you currently do about invoices, but this system should be able to create some record of prepayments.
If you don't want to switch to accrual basis then -- assuming, as always, that you are not legally obliged to (no inventory, less than a couple of million revenues, please check with someone who knows the relevant tax info) -- you don't need to, no matter what the accountant says. Because she should certainly be able to explain to you why it is a better choice for your business.
It is possible that Xero is not the right system for you also.
posted by jeather at 6:32 PM on October 20, 2013
If you don't want to switch to accrual basis then -- assuming, as always, that you are not legally obliged to (no inventory, less than a couple of million revenues, please check with someone who knows the relevant tax info) -- you don't need to, no matter what the accountant says. Because she should certainly be able to explain to you why it is a better choice for your business.
It is possible that Xero is not the right system for you also.
posted by jeather at 6:32 PM on October 20, 2013
What happens if the client cancels? Do you still keep the money, or do you refund some or all of it?
I'm with rue72 and your accountant IF it's just a prepayment for the work you're going to do. You got the money, but you still owe the service. It should go into 'unearned revenue' which is a liability account until you provide the service. At that time, you credit sales and debit the amount from unearned revenue.
If it's a non-refundable deposit, that might be different.
posted by ctmf at 11:03 PM on October 20, 2013
I'm with rue72 and your accountant IF it's just a prepayment for the work you're going to do. You got the money, but you still owe the service. It should go into 'unearned revenue' which is a liability account until you provide the service. At that time, you credit sales and debit the amount from unearned revenue.
If it's a non-refundable deposit, that might be different.
posted by ctmf at 11:03 PM on October 20, 2013
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posted by barnoley at 3:09 PM on October 20, 2013