Ledger Nightmares: Entries only an accountant should make

One of my favorite holiday traditions is watching “The Nightmare Before Christmas”. For those of you unfamiliar with the movie, here is the basic plot synopsis: The leader of Halloween Town takes an accidental visit to the land of Christmas and is so enchanted by all of it that he decides to give Santa the “year off” and take over in his place. The residents of Halloween Town are, needless to say, ill-suited for this task, and the results are hilarious and horrifying.

The problem is, they see just enough of Christmas to think they know how to emulate it, but they misunderstand the core concepts.

This is a frequent issue when non-accountants take on bookkeeping duties. Recording sales and expenses is one thing, but there are certain entries which really should be left to the professionals.

This week we’re looking at the most frequently-confused accounting principles and discussing why it is better to not attempt these yourself.

Setting Up Chart of Accounts & Opening Balances

Though you would think bookkeeping would be simple with a clean slate, getting your company started can be one of the most complicated times, accounting-wise. (Okay, everything about starting a company is complicated.) There are legal and professional expenses, you must determine book value of any assets which you already have, and entering equity amounts can be difficult. (In particular, how you record money the owner contribues, whether as paid-in capital or a loan from the owner, can affect tax liability.)

When these issues are compounded by extra demands on the owner’s time and focus (not to mention the learning curve associated with self-training on accounting software), you have a recipe for inaccuracies.

While you are setting up your business, get someone with experience to jump-start the accounting side of it.

Capital Expenditures

Expanding your business is an exciting time, particularly when you’re investing in new locations. Whenever you are spending funds or assuming liability to obtain a physical asset which will be used for productive purposes for at least one year, that is a capital expenditure. Capital expenditures can be land, buildings, machinery, or even software upgrades (generally provided they meet a certain cost threshold).

For an amateur bookkeeper, capital expenditures might appear deceptively easy. Buying some land for a new plant site? Debit Land, credit Notes Payable, and expense whatever incidentals come up along the way, right?

Of course not! If it was that easy, everyone would do their own books.

If you record a capital expenditure like that, your book value will be off and when you calculate depreciation it will be inaccurate. (We’ll get to depreciation and other contra-accounts later.)

Rather, when capital expenditures are recorded, you are also to include in the book value the net cost of getting the property ready for use. If the ground needed to be levelled, that cost would be included. Likewise, if there were salvageable materials present which were then sold, that gain would be used to reduce the book value. Certain legal and professional fees surrounding the sale may be included as well. It’s all very interesting (but also very complicated for a layperson).

Referring to our example, what about that Note Payable? Assuming it’s accruing interest, at year-end you’ll need to make…

Adjusting Entries

Month-end and year-end adjusting entries are both necessary and a pain in the neck. There are several types of adjusting entries, such as adjustments for goods or services clients prepaid you for (Unearned Revenue), expensing those things for which you prepaid, recording accrued interest, etc.

One of the biggest dangers at year-end is recording adjustments to inventory. Even with consistent inventory tracking throughout the year, there are generally still adjustments to be made at year-end. Mistakes in inventory recording can result in over or understated COGS (Cost of Goods Sold) and inaccurate tax liability calculations. For reasons such as this, it’s usually a good idea to have an accountant look at your year-end statements before preparing taxes. (Remember that many CPAs will simply prepare your taxes based on the statements you give them. For that reason, be sure you are hiring someone who will actually look for issues in the accounts themselves.)

Even if it’s not a special occassion, such as making a major purchase or at year-end, there are still transactions that require bookkeeping assistance. Notably, any of those involving…

Contra Accounts

A contra account is one which is intended to have an opposite normal balance for that account classification. For instance, a sales discount is a contra revenue account, so it has a normal debit balance (whereas most revenue accounts have a normal credit balance).

Contra account entries have the potential to be very tricky, and the greatest offender for this is depreciation. Recording depreciation is essential for accurately estimating the current value of assets, but calculating it is a complicated process. First, life expectancy of the asset and salvage value must be computed. After that, straight-line depreciation is the simplest, but nowhere near as accurate as usage-based or the double-declining balance method. Finally, when the asset is finally sold or scrapped, the gain or loss must be calculated and recorded based on the present value. Of course, any errors can then negatively affect tax liability.

Long story short, any time you feel like you’re getting in over your head, ask a professional. Trying to D-I-Y complicated accounting entries can turn your General Ledger into a horror story.

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