A very interesting piece on BBC Radio 4 – history of double entry accounting
BBC Radio 4 are this week (Mar 8th, 2010) and next broadcasting a short history of the double entry system of accounting. Here’s a link. There are 10 episodes, each day Monday to Friday, at 15:45.
IFRS for SMEs
I have written previously about the FRSSE, which is a summarised set of accounting rules used by some private companies in the UK and Ireland. Since 2005, all public companies throughout Europe use what are called International Financial Reporting Standards (IFRS). These standards are complex and the bound volume runs to a few thousand pages. Not the sort of thing a smaller private company might find all that useful when preparing its financial statements. In the UK, a body called the Accounting Standards Board (ASB) is responsible for implementing all accounting standards. In August 2009, the ASB decided to adopt the IFRS for Small and Medium-sized Entreprises (IFRSSME) with effect from January 1, 2012. According to accounting firm Deloitte (see this link), this means that approximately 50,000 larger private companies will have to adopt the IFRSSME, while about 2 million others can continue to use the FRSSE. Unlike its big cousins, the IFRSSME is small and compact, at around 230 pages of rules. The International Accounting Standards Board (IASB) hope that the IFRSSME will meet the needs of SMEs, who typically account for 90-95% of businesses in any country. Unlike the full IFRS, the IFRSSME is not compulsory in the UK or any other EU nation, but watch this space.
The IFRSSME can be downloaded free at this link.
A quick check on new customers
In most businesses, you’ll have to sell on credit to increase sales. Larger businesses normally have plenty of resources to check out new customers before granting any credit. For example, they might use credit rating agencies or even have credit insurance in the event of non-payment. But, for a small or growing business such things can be a bit more awkward, time-consuming and costly. So here are a few ideas which any business can do quickly and free of charge on the web. These are not fool proof, but at least verify that the most basic information given by prospective customers is correct. So if you smell a rat, try these out. It’s better than loosing money.
- Ask for and verify the VAT number of the customer. This can be done for any European VAT registered person or company at this website http://ec.europa.eu/taxation_customs/vies/ . Just fill in the details and you get the address back to you. This can be quickly checked against the address provided.
- If the business is a company, go to the website of the company registration authority or local chamber of commerce to verify the company name. Most such websites e.g. the UK Companies House (http://www.companieshouse.gov.uk/) or the Irish Companies Registration Office (www.cro.ie) allow you to search by company name and number and view basic data free.
- Taking the previous point a step further, you can usually buy a copy of the most recent accounts of any company from the relevant authority. These can give you great information at a relatively low cost (£1 per set of accounts in the UK or €2.50 in Ireland.
- Don’t forget about social sites like Facebook and Twitter. It’s amazing how many business set up pages. While you’re unlikely to get detailed information on finances, a thriving and active site with lots of followers and fans might tell you something.
Of course, as your business grows you may be able to delegate some of this or pay for a more sophisticated service. Meanwhile, take care and try to get the right balance between increasing sales and granting credit to the wrong people.
Global IFRS adoption
While the minute detail of the many accounting standards is not one of the topics I like to write about, it occured to me recently ” how international are the International Financial Reporting Standards (IFRS)?”. A key advantage of one set of reporting standards is ease of comparison and understanding of financial statements. Since 2005, all EU listed companies are required to use IFRS and some member states allow smaller companies to use it. On a global scale, approximately 120 countries have adopted IFRS, with about 90 of these making adoption mandatory for all listed companies. Most of the G20 countries have either adopted IFRS or set dates for adoption (see http://is.gd/jMVJw). The US Federal Accounting Standards Board and the International Accounting Standards Board (the body who issue IFRS) have agreed a date of June 2011 for convergence of US and International standards. Also, some countries are planning to adopt the IFRS for SME, which is a cut down version of the full IFRS set. This will not only extent IFRS principles to SME but possibly to developing economies also. So the spread of IFRS is pretty wide, and by about the middle of this decade, the standards will be quite international in nature and name.
Settling your tax debts
As the old saying goes, “only two things in life are certain, death and taxes”. In the current economic climate, many businesses are dying off, but the taxes associated with them don’t necessarily “die” so quick. Getting into debt with the tax authorities is never a good idea, but if your business is failing this may be inevitable. Over the years I have had some experience with tax authorities (mainly the Irish Revenue Commissioners), so here are some tips:
1. Contact the tax authorities as soon as possible. Informing them not only buys some time, but it may also begin a negotiation process.
2. Assess the taxes owed. Once you know what is owed, you’re in a better position to see how bad the problem is.
3. Assess all assets and liabilities of your business. If you are a sole trader or part of a partnership, assess all personal assets, liabilities and living expenses. Undoubtedly the tax authority will do this exercise so you might as well be one step ahead.
4. From 2 & 3, you should be able to start a negotiation process. As I said in 1 above, by contacting the tax authority early, you have a much better chance of doing some kind of deal.
5. If you can make a deal to pay a lower amount than you owe, or to pay by instalments, be sure to stick to the arrangement or inform the tax authority if you have problems.
While dealing with tax debts is not the nicest thing in the world, try to be honest and do a realistic deal where possible. Ignoring the problem makes it worse. And, particularly if you are a sole trader, ignoring a tax debt can affect any future business prospects.
Are you afraid of numbers?
Numerophobia is the fear of numbers. We all know that some numbers might be “unlucky”, like 13 or 666. As a trained accountant I’d be in serious bother if I had such a phobia. Thankfully, I don’t and I have actually stayed in a room number 666 in a hotel in Cologne, Germany some years ago and had an enjoyable stay. I often hear people saying they hate accounting and tax because there are too many numbers. Is this a phobia or just putting things on the long finger? Well, the latter might be the more common reason, particularly when the numbers look bad. In a NY Times article (21/11/2009), Jacob Soll says that anxiety about accounting and taxation often increases to the point of denial. He quotes a 2005 study by Lloyds TSB (UK) which reported that accounting anxiety has led to “balance denial syndrome,” in which bank customers so fear being in the red that they systematically ignore their bank statements. Not really a good idea! Let’s think back to what accounting is about. Its purpose is collect, collate and communicate information (usually of a financial nature). As an example, let’s assume a small business keeps poor records or worse, none at all. In such a case, a bank statement might be the only indicator of how a business is performing. So to ignore it is to cut-off the only source of communicated accounting information a business has. In practice, letting records fall behind is more common than none at all. And, we may let things fall behind because we can’t face the bad story the records tell – especially in the current economic climate. However, this is big mistake. Having the courage to face the books and realise they don’t tell a good story is the first step to solving the problem. As Soll says, “It might be that the first step to balancing the books is finding the courage to face keeping them”. So hands up, admit it and get down to solving your problems. If you’re too busy putting out other fires, call your accountant and ask them to help.
Accounting and Innovation
Innovation is the life-blood of any business. New products, services and ways of doing business all lead to sustainable longer-term profits. Sometimes innovation comes at a substantial cost, for example in research and development costs. In these recessionary times, budgets for things like product research and development are often slashed. Of course accountants are blamed for this. But can accountants play a role in injecting innovation into businesses in these tough times. According to Richard Young, writing in Financial Management (September, 2009), accountants can inject a dose of realism in to innovative ideas and projects. They can be a ‘wet blanket’, which although has a negative tone, may actually be exactly what is needed in lean times. With a smaller pot of money to be spent on product innovation, accountants can help determine the longer-term profitability of new products or services, preventing great ideas becoming poor sellers. Accountants also bring structure, based on their expertise of the many business processes involved in getting innovative ideas afloat. For example, accountants can ensure that the costs of any new product are minimised – production costs, marketing and distribution costs etc. They can thus help take the innovation to something which is based on costs and profits, something which investors and managers readily understand. Innovative and creative people are often uncomfortable with such language.
Accounting rules in smaller companies
Limited companies must prepare financial statement in accordance with accounting standards and Company Law. As you can imagine, complicated rules and laws are often way too much for a small company to deal with. Most to the time, directors of small companies leave the work of preparing financial statement up to practicing accountants. In fact, in the UK and Ireland, small companies are also exempt from the requirement to have their financial statements audited provided they meet certain conditions.
In June 2008, the UK’s Accounting Standards Board (ASB) issue an accounting standard specifically designed to cater for and simplify the accounting rule for small companies. What constitutes a small company is specified by Company Law. In the UK, any company with turnover of not more than £5.6m, a balance sheet total of not more than £2.8m and has less than 50 employees is a small company. If a business meets these criteria, it can then adopt the ASB’s Financial Reporting Standard for Small Entities (FRRSE). This standard is very useful in that it incorporates all requirements relating to financial statements as set out in Company Law. Thus, by following this standard in the preparation of its accounts, a company is also fully compliant with the law. The FRRSE covers many areas of financial statements- for example: the profit and loss account, fixed assets, current assets, the Directors Report and much more. It also exempts smaller companies from some more complex requirements of other accounting standards. If your business is a small company, it might be worth while asking your accountant if the FRRSE is suitable for you. It might simplify their work, and as a result save you some fees.
Here is a link to the ASB’s website, where you can download the FRRSE for free;
http://www.frc.org.uk/documents/pagemanager/asb/FRSSE/FRSSE%20Web%20optimized%20FINAL.pdf
The profit and loss account (income statement)
This brief post covers the basics of the profit and loss account. The profit and loss accounts lists all income and expenditure, with the difference being they profit or loss made by the business. The profit and loss account has two parts, albeit in the same statement. The first part account calculates the profit earned from buying and selling goods. This is called the Trading account.
Here’s an example of the layout.
Trading account for Red Books for year ended 31/12/2009
|
€/£ |
€/£ |
|
| Sales |
|
250,000 |
| LESS COST OF SALES |
|
|
| Opening stock |
20,000 |
|
| Purchases |
150,000 |
|
|
170,000 |
|
|
| Less closing stock |
30,000 |
|
| Cost of sales |
|
140,000 |
| Gross profit |
|
110,000 |
Here’s a brief explanation of each of the some of the items and terms above. First, there is the title of the account. It informs the user of the name of the statement (what), the name of the business (who) and the time period involved (when).
Sales: The amount of money earned by the business selling books in the past year i.e. Income. Sales returns/returns in may have to be subtracted to get this figure.
LESS COST OF SALES: this is a heading, which indicates that this calculation is going to be completed. This calculation will work out the cost of all the books that were sold in the year. It is calculated as follows
Cost of sales = opening stock + purchases – closing stock.
Opening stock: This is the value of stock left over from the previous year. This stock will be the first to be sold in the this year, thus it is a cost for this year (c.f. the accruals concept)
Purchases: This is the cost of all the new books bought during the year. (Additional costs like carriage in and import duty might be added to the purchase cost). Purchase returns/returns out may have to be subtracted.
Closing stock: This is the value of all the books left at the end of the year. It is subtracted from opening stock and purchases, as it does not form part of the goods sold during this year (c.f. accruals concept).
Cost of sales: This is the answer to the calculation of the cost of sales.
Gross profit: This measures the profit the business makes by buying and selling books. It is calculated as follows:
Gross profit = Sales – Cost of Sales
The second part, the profit and loss account calculates the profit the business has earned after allowing for all the expenses incurred in running the business. Here’s an example following on from the trading account above
Profit and loss account for Red Books for year ended 31/12/2009
| €/£ | €/£ | |
| Gross Profit | 110,000 | |
| LESS EXPENSES | ||
| Wages and salaries | 40,000 | |
| Depreciation | 20,000 | |
| Light, heat and telephone | 10,000 | 70,000 |
| Net Profit | 40,000 |
As you can see, the profit and loss account starts with the Gross Profit and deducts expenses to arrive at Net Profit. Net profit is the profit that is owed to the owner(s) of the business. In the case of a sole trader, this forms part of the capital of the business, whereas with a company the shareholders may be paid a dividend from available profits.
All other elements from the Trial Balance i.e. assets, liabilities and capital do not appear on the Profit and Loss account, but the balance sheet.
Tracking costs in an engineering contract business
In business sectors such as engineering, ship-building or construction, costs are often incurred over many years. Also, as contracts rather than products are the mainstay of such sectors, costs are accumulated for each contract separately. For managers and accountants who want to track costs for each contract there are a number of things to watch out for. The first thing is that many more costs can be attributed to a particular contract. For example, materials and equipment used on contracts might be specific to a contract. Also, materials might be left over and used on other contracts, or even be moved around between contracts. In some cases, equipment is often useless at the end of a contract e.g. tunnel boring machines are often left in the ground as it’s too expensive to remove them. Labour costs are probably the easiest to allocate to contracts. You just need to get the costs of all employees working on the contract. Many other costs which might be considered as overheads are often easily apportioned to a contract. For example, a large contract might have an office on-site. All costs of running the office, which would normally be an overhead cost, would become a direct cost of the contract. And this is the key feature of contracting type businesses – that more costs are classified as direct. Even plant and equipment might be a direct cost, as in the case of the Channel Tunnel where the tunnel boring machines were buried beneath the seabed (see http://en.wikipedia.org/wiki/Channel_Tunnel). A high cost no doubt, but the salvage cost would have been greater.
To manage a contracting type business, you need to capture costs for each contract. This is usually simple enough, as most costs are direct costs and easily identifiable. The key thing is to keep an account of each contracts costs and revenues. This means profitability of a contract can be easily assessed. Costs will usually be approved by an architect or engineer before being used to calculate profits. Even then, accounting rules suggest that profits should not be recorded in the financial statements until the outcome of a contract is reasonably certain. In practice, this means that as a contract gets nearer completion, a higher proportion of profit is recorded. If a loss is predicted, this is recorded immediately in the books of account.
Accounting and HR
In the July 2009 (July 30th) edition of People Management, the journal of the Chartered Institute of Personnel and Development (CIPD), Claire Warren provides an example of the importance of accounting information to HR professionals. The article touts the often cited expression ‘people are our greatest asset’, but questions how many HR professionals appreciate the full costs of people in an organisation.
According to Vanessa Robinson of the CIPD, HR professions shouldn’t ‘merely say “people are our greatest asset”, but look at the profit and loss account and see what they cost!’ The problem is that many HR professionals may not have sufficient basic accounting knowledge to understand basic accounting principles. They need to be familiar with the basic financial statements – the profit and loss account (income statement), balance sheet and cash flow statement. What this article tells us is something we as accountants already know – that accounting is a communication medium, a language indeed, that not everyone understands. Having said that, while HR professionals may not think they require fluency in accounting, they do need to make business decisions which are underpinned by sound financial information. Having an understanding of accounting information (rather than just accepting it from the accountants) will benefit HR and other professionals in an organisation. The article in People Management is a great start for anyone who wants to know the basics, so take a few minutes to read it.
Free software from Quickbooks – a brief review
The most basic version of Quickbooks accounting software, Quickbooks SimpleStart, is available for free download (see www.quickbooks.co.uk). Given that it is free, is it suitable for a small or start-up business? The answer is yes, but there are some things to watch out for.
The good things first. Well, its free to begin with, no catches except the odd email. It is not a trial version, so no hidden expiry dates or missing functionality. It can do the basic business tasks: track sales and expenses, instantly create sales invoices, pay bills and print cheques. It is ideal for a small business or start-up. As the website says it’s ‘Built for Freelance Designers, Dentists, Flower Shops, Tech Startups, Chippies, Property Managers, Personal Trainers”, to name but a few.
So where’s the catch? Well, there is one small limitation and that is in the number of customers and suppliers allowed. Both are set at a maximum of 20. If you have more than this, you will have to pay for the full version of SimpleStart, which costs about £80. Despite this limitation, the free version can still be used for a while and you can get used to the software before paying out some money. For the first time entrepreneur who wants to keep on top of accounting from day one, I think it’s worth a try.
Breaking even in your business
It’s always a good to know the costs of your business. But how can you be sure you sell enough to cover costs. The answer is relatively simple, using the notion of breakeven.
First, you need to know the fixed costs of your business. These are the one you incur even if you business is not selling e.g. rent. Then, you need to know the cost of one of your products or one delivery of your service. This might not be as easy as it sounds, but try you best. Now you can deduct these costs from you selling price and work out a profit per unit. You can then work out the sales level at this profit which is needed to cover the fixed costs. Anything beyond this and you’re making a profit. You can apply this same principle to new products too. Being a relatively simple technique, been able to calculate a breakeven point is a very useful tool for any entrepreneur.
The basics of double-entry accounting.
The double-entry system of accounting is used to records business transactions. No matter how simple or complex the transaction, it is recorded in ledger accounts with a debit and credit entry. The rules are double-entry accounting are incorporated into all accounting software, even if you don’t see them!
The double-entry accountin system ensures the integrity of business transactions and their financial values. It does this by ensuring that each individual transaction is recorded in at least two different ledger accounts and so implementing a double checking system for every transaction. It does this by first identifying values as either a Debit or a Credit value. A Debit value will always be recorded on the debit side (left hand side) of a ledger account and the credit value will be recorded on the credit side (right hand side) of a ledger account. A ledger has both a Debit (left) side and a Credit (right) side. If the values on the debit side are greater than the value of the credit side of the nominal ledger then that nominal ledger is said to have a debit balance and vice versa.
Luca Pacioli, an Italian monk, was the first to document the system in a mathematics textbook of 1494. Pacioli is often called the “father of accounting” because he was the first to publish a detailed description of the double-entry system, thus enabling others to study and use it
Click on this link for a brief animated tutorial I have put together to explain the workings of double-entry.
Taking stock – some tips for stock-taking
If your business involves the sale of products then you may be familiar with the concept of stock-taking (or doing an inventory count). Most of the time, businesses have computerised stock control systems which keep track of every product movement in and out. Well, in theory at least. No matter how accurate the stock control system, manual periodic stock counts are a must for any business. These stock checks verify what the system says should be in stock. Any differences can then be investigated and corrected.
The frequency and detail of a stock check depends on a number of factors. The value of items held in stock is probably the most important driver of the frequency of stock takes. Normally, high value items receive a lot of regular verification simply due to the financial loss which might be suffered by the business. Small items like pens and pencils, or nuts and screws, might be ignored in stock checks. A second factor is what I call ‘walkability’. For example, a high street newsagent might sell items like lottery scratch cards, pre-paid bus tickets or packs of cigarettes. All these are small, easy to conceal and readily saleable for cash. One high street retailer I know actually checks stock of lottery cards and bus tickets every night. It only takes a few minutes.
When deciding how often to do stock checks and what to check, try to keep these two factors in mind. You don’t need to count everything every time. It’s much smarter to be focused – it saves you time and, potentially, money.
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