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Common Mistakes and How to Avoid Them

In analysing clients’ books for their year end accounting there are certain mistakes that I am finding that clients have made with their book-keeping that could easily be avoided:

Duplications

One mistake that I have quite commonly found, not only in my small client’s books, but also previously, when working for much larger organisations, is duplication. This is particularly so for purchase invoices / receipts.

One of the reasons that this occurs is that there may be two copies of an invoice or receipt. An invoice may have been faxed or emailed initially but then a final invoice sent through the post (maybe with goods ordered), or an initial receipt may have been issued and then followed up with a valid tax invoice. Of course, sometimes the duplication problem occurs even when there is only one copy (as I have seen with a couple of my clients).

There are two effective ways to ensure that duplicate entries do not happen:

  1. When using an accounting system ensure that the correct invoice number is entered against the correct supplier. Good accounting systems will either not allow you to enter two identical invoice numbers against the same supplier, or at the very least they will flag the fact that you have done so.
  2. Be organised when entering your paperwork into whatever system you are using. Arrange your paperwork by date order before you even start entering it (this should enable you to instantly see if you have any duplicate paperwork), and then immediately file any paperwork dealt with. This ensures that you will not enter the same lot of paperwork again.


Omissions

Another mistake that I have come across is to miss an entry completely. Of course this could work either for or against the client depending on whether it is a sales or purchase entry that was missed.

The primary way to avoid this error is to reconcile all your entries back to your bank account. In general, if you use an accounting program such as Xero or Banklink, then the automatic bank feeds should ensure that omissions do not happen. However, if you don’t use a program with automatic bank feeds then you will need to manually reconcile all your entries.

The easy omission to make that would not necessarily be picked up by bank reconciliations is that of cash receipts. I know from having a market stall for my jewellery that any sale paid for in cash could easily be overlooked and not included in your accounts.

There are two main ways to ensure that these sales are properly accounted for:

  1. Bank ALL money received for cash sales – don’t be tempted to use any of it for every day spending money.
  2. Keep an up to date written record of all cash received for sales and then transfer these details to your accounting records at the earliest opportunity. (At the markets I write down everything that is sold so that I can adjust both my sales and inventory records when I get back home).

Cost of Sales

Another common error is to cost all purchases of goods for resale, or materials for making goods, directly to cost of sales. In fact, all these types of purchases should instead be costed to “stock” or “inventory”. The cost of purchasing goods for resale cannot be treated as a Cost of Sale until the goods have actually been sold. Likewise, the cost of materials, cannot be treated as a Cost of Sale until the materials have been used to make a product and that product has been sold. (I won’t go into further detail here as I have a previously post specifically about Cost of Sales).

Meal Costs

One common misconception appears to be that meal or refreshment costs can be treated as taxable business costs as long as the meal or refreshments are taken whilst out and about on business matters. In fact, I know of one Franchise Organisation who actually told their franchisees that this was the case. IT IS NOT!

While as an employee, it may well have been possible to claim the cost of a meal or refreshment from an employer while out on company business, that employer would NOT have been able to claim this cost in their accounts as a taxable expense.

If you particularly want to you can treat these costs as business expenses, however, they cannot be treated as TAXABLE business expenses. In other words the costs would have to be added to your accounts after tax and not before.

If the meal is taken with a genuine client, then 50% of the cost can be treated as a taxable business expense but you still can’t claim the whole cost against tax.

Equipment/Tools etc. Costing $100 or More

Another common error is to write off items that should in fact have been capitalised. If a piece of equipment, or a tool etc. that you have purchased for your business costs $100 or more then it has to be capitalised and you can’t claim the whole cost in the year of purchase. It doesn’t matter what it is, whether it is a mobile phone, a piece of furniture, or a tool, if it cost $100 or more than it has to be treated as a capital purchase.

The thing to really watch out for here is when several items are purchased together, that may individually cost less than $100, but that in total cost $100 or more. If they are all purchased for the same type of thing, i.e. refurnishing an office, or building a computer etc. then it is the total, not the individual cost that is relevant.

If in doubt about any of the items mentioned above then please check them with your accountant!

Cost of Sales for Handmade Businesses

A potentially big mistake that can be made by small businesses is in thinking that the total cost of the purchases of materials etc. that they have made through the year becomes their “cost of sales” figure for the year. This is wrong!

Cost of Purchasing Materials for the year DOES NOT EQUAL Cost of Sales for the year!

Every purchase of materials that you make is actually a cost against your inventory or stock.

Inventory/Stock

Any handmade business, or indeed any small business that makes its own product, will have two different inventories, one will be for raw materials, and one will be for finished products. Every time you purchase some raw materials you are increasing the size of your raw material inventory. Then, as you use some of those materials to make a product, so the raw material inventory will decrease and the finished goods inventory will increase. Equally, when you sell a product, so the finished goods inventory will decrease.

So, to give an example:


RAW MATERIAL STOCK
FINISHED PRODUCT STOCK
Opening Balances
1,000.00
2,000.00
Purchase of Materials
500.00

Sub-Total
1,500.00
2,000.00
Make a Product
-600.00
600.00
Sub-Total
900.00
2,600.00
Sell a Product

-400.00
Closing Balances
900.00
  2,200.00


This of course is just a very simple example of the movements between inventory values when buying materials, making products and selling products.

With regard to the Finished Product stock, this can be costed as either cost price or selling price. Personally I recommend that for accounting purposes that your product inventory is costed at materials cost (plus labour costs if required). For my own jewellery inventory I have two columns, one for materials cost and one for sales value. I therefore have the materials costing of the inventory for my accounts but still know what the sales value of the inventory is.

It is very important to understand inventories because inventory balances and movements are used to calculate the cost of sales for the year.

Cost of Sales

Cost of sales can be determined in two ways: The best (and probably easiest way) to do this is via the inventory balances. The simple calculations is as follows:

  • Opening Inventory Balances
  • Plus – Purchases of Materials
  • Less – Closing Inventory Balances
  • Equals Cost of Sales


So, to use the figures from the inventory example above:


TOTAL STOCK
Opening Balances
3,000.00
Plus: Purchases of Materials
500.00
Less: Closing Balances
-3,100.00
Equals: Cost of Sales
  400.00


Giving such simple examples you will see quite easily what the second way of determining the Cost of Sales is – quite simply it is the cost of the product that has been sold (as shown in red).

Now this may seem the easier option when presented with such a simple example, but when there is a lot of product that has been sold during the year, using the balances as shown above becomes the easier option to use.

Of course in reality inventories will be much more detailed than the examples shown above as each material should be listed with descriptions of materials, cost per item, quantities, total cost for items etc., as should each completed product.

So to summarise:

Cost of Sales for the Year = Cost of making the Products Sold in the Year.

Accountants - Chartered, Certified or Management?

You may have noticed that there are a few different types of accountant out there and wondered what on earth the difference is between them. The types of accountant that you are likely to see are chartered accountant, certified accountant, management accountant and even public accountant. Or of course you may have just assumed that it is only a “Chartered Accountant” who is actually a qualified accountant which isn’t the case.

In fact, the different descriptions, or designations, are usually an indication of the professional accountancy body that the accountant qualified with. In England, where I originally qualified as an accountant, there are several different professional bodies to choose from, all of which give you a professional accountancy qualification, and the majority of which also offer their qualifications on a global level:

  • CIMA – Chartered Institute of Management Accountants Qualified members are given a designation of CGMA or Chartered Global Management Accountant
  • ICAEW – Institute of Chartered Accountants in England and Wales Qualified members are given a designation of ACA or Chartered Accountant
  • ACCA – Association of Chartered Certified Accountants Qualified members are given a designation of ACCA or Chartered Certified Accountant
  • CIPFA – Chartered Institute of Public Finance and Accountancy Qualified members are given a designation of CPFA or Chartered Public Finance Accountant

Each of these professional bodies has a system of examinations and required professional experience before membership is granted and each body also requires its members to undertake a minimum number of hours “continued professional development” each year.

In Australia there are three professional accountancy bodies:

  • CPA Australia – Certified Practising Accountants
  • ICA Australia – Institute of Chartered Accountants
  • IPA Australia – Institute of Public Accountants

And in New Zealand there is just the one:

  • NZICA – New Zealand Institute of Chartered Accountants

Other countries will have all also have their equivalent accountancy bodies.

So what is the difference? Well, in simple terms, the difference tends to come through in specialisation. All qualified accountants, regardless of which accountancy body they qualified with will cover certain subjects such as Accounting Standards, Financial Statements, Tax, Business Law etc. However, some accountancy bodies, such as CIMA for example, will have a higher proportion of concentration (exam wise) on management accounting, costing, business finance etc. while others such as ICAEW will have a larger concentration (exam wise) on auditing, taxation and law.

Public accountants have, as their name implies, much more learning toward accounting for public finance and are more likely to work in publicly funded environments such as government departments or district councils.

The professional experience required to gain full membership of an accountancy body (once exams have been completed) will also generally have different requirements between the accountancy bodies in terms of the disciplines for which minimum requirements are needed.

As a general rule of thumb most chartered accountants will have started out working in an accountancy practise whereas most management or certified accountants will have started out in the accounts department of a commercial company. However, career directions can change and over time the different “types” of accountants can become much more intermingled with chartered accountants in commerce and management or certified accountants in practise.

I remember when interviewing a candidate for a position once (in England) I asked her why she had chosen to study with the ACCA. Her answer, I felt, was quite insightful and gave some distinction between the different designations. She answered that CIMA was very industry based, ICAEW was very practise based whereas ACCA was more middle of the road, somewhere between the other two.

So is one type of accountant better than another? While many of my colleagues are likely to argue with me, arguing in favour of their particular institution, the simple answer is no. We are all qualified accountants, regardless of which designation we may hold, and through continued professional development, we are all qualified and capable of doing the work that we do.

Accounting Terminology

Most trades and professions have their own ‘language’ and accountants are no exception. How many times have you heard certain account ting terms or phases and wondered what on earth the person using them is talking about?

Well in order to help you out, here are some of the more commonly used terms used by accountants in alphabetical order:


Accounts PayableAlso known as “Bought Ledger” or “Purchase Ledger”
Amounts companies owe suppliers for goods and services. Listed in the current liabilities section on the statement of financial position.

Accounts ReceivableAlso known as “Sales Ledger”
Amounts customers owe a company from sales of goods or services that the company expects to collect within one year. Listed in the current assets section on the statement of financial position.

Accruals
A list of expenses that have been incurred and expensed, but not paid or a list of sales that have been completed, but not yet billed

Assets
Assets are resources controlled by the entity as a result of past events (usually transactions), from which future economic benefits are expected to flow to the entity.

Balance Sheet
Summary of a company's financial status, including assets, liabilities, and equity

Budgeting
A detailed plan, over a defined period (usually one year) with dollar amounts

Chart of Accounts
A listing of a company's accounts and their corresponding numbers

Cash Flow
A summary of cash received and disbursed, within a specified period of time, showing the beginning and ending amounts

Credit
At least one component of every accounting transaction is a credit. Credits increase liabilities and equity and decrease assets.

Debit
At least one component of every accounting transaction is a debit. Debits increase assets and decrease liabilities and equity.

Depreciation
Recognising the decrease in the value of an asset due to age and use

Dividends
Amounts paid to shareholders out of current or retained earnings

Double-Entry Bookkeeping
System of accounting in which every transaction has a corresponding positive and negative entry (debits and credits)

Drawings
The money that you take out of a business to either live on and/or pay any personal expenses. Drawings are part of the net profit and not a business expense.

Equity
Money owed to the owner or owners of a company

Financial Accounting
The preparation and presentation of financial reports showing business cash flow, profit/financial performance and financial position. The analysis and interpretation of financial statements to help business owners and managers make informed decisions about their business.

Financial Year
A company's usual 12 month reporting period.

Financial Statement
A record containing the balance sheet and the income/profit and loss statement

Fixed Asset
Long-term tangible property; building, land, computers, etc.

General Ledger
A record of all financial transactions within an entity

Gross Profit
The difference between a business’s total sales and its cost of sales. Listed as a category on the statement of earnings. Also called gross income.

Invoice
The original billing from the seller to the buyer, outlining what was purchased and the terms of sale, payment, etc.

Journal
A record for recording transactions

Liabilities
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Management Accounting
Provides information about particular activities within a business, including budgets, costing and evaluating business activities.

Net Profit Also known as “Net Income” 
Money remaining after all expenses and taxes have been paid

Posting
The process of entering then permanently saving or “archiving” accounting data

Profit/Loss Statement
Also known as "Income Statement" A summary of income and expenses

Reconciliation
The process of matching one set of data to another; i.e. the bank statement to the check register, the accounts payable journal to the general ledger, etc.

Retained Earnings
The amount of net profit retained and not paid out to shareholders over the life of the business

Revenue
Total income before expenses.

Statement of Account
A summary of amounts owed to a vendor, lender, etc.

Stock  Also known as “Inventory”
Merchandise purchased or manufactured for resale at a profit

Trial Balance
A list of the general ledger accounts and their total balances

Turnover   Also known as “Operating Income”
Income generated from regular business operations