Some Business Costs Are Not Recorded as Expenses

Learning one basic rule about business expenditures will vastly improve bookkeeping accuracy and avoid tax-reporting mistakes. This standard is simply the fact that some (but not all) purchases of items used in business are not expenses. These exceptions are assets.

Recording Assets

Business assets appear on the balance sheet, which is a key component of your financial statements. By contrast, the income statement has the incomplete picture of only revenue and expenses. The balance sheet shows you what happened to profit that remained after paying expenses with revenue. Over time, the balance sheet may indicate that profit was used to increase funds in the bank account or repay loans. Another use of profit is acquisition of fixed assets, such as new equipment, machinery or building improvements.

Great care is necessary to identify expenditures that should be classified as fixed assets on the balance sheet. Most importantly, accounting help may be necessary when you borrow money to acquire a fixed asset. The entire asset cost and loan amount are recorded. Loan payments are therefore not expenses or asset additions. They are reductions in the loan balances on the balance sheet.

Fixed Asset Tax Classification

Improperly recording an asset purchase as an expense results in understated profit. This upsets tax planning. For income tax purposes, the costs of fixed assets are deducted as depreciation over time. Complicating this matter is the variety of periods over which different types of assets are depreciated. Your accountant therefore needs not only the cost for a fixed asset but also a description and the date when it was first used in business.

As a general rule, depreciable fixed assets are property with a useful life of more than one year. But small assets are an exception. A screwdriver, for example, may be an office expense on the income statement, although it will last for more than a year. But a programmable robotic assembly machine should be classified as a fixed asset on the balance sheet.

The threshold amount that identifies when a purchase qualifies for expensing tends to vary based on business size. For small businesses, the U.S. Internal Revenue Service generally permits an expense deduction for any single item with a cost of less than $2,500. Anything with a greater cost and a useful life exceeding one year should be classified as a fixed asset. Its cost is then depreciated over the allowable length of time permitted by the tax rules for the type of property.

Additions to Asset Value

An especially complicated purchase to classify is an improvement to an existing asset. Expenditures that improve property are categorized as new assets. Improvements to buildings are the most common area of confusion. But the issue also applies to machinery.

In general, a cost that merely makes something operate better is an expense. Conversely, you’ve acquired an asset when you spend money that adds to the life of a property, expands its size or is crucial to its functionality. For instance, fixing a hole in the ceiling may be a repair expense, but replacing the entire roof is likely considered an asset. The IRS has threshold amounts to distinguish repair expenses from improvement assets. These quantities vary based on multiple factors. So checking with your accountant about the numbers that apply to your business is the ideal route for avoiding errors.

Considerations for Accurate Payroll Preparation

The greatest bookkeeping challenge for most small business owners is preparation of payroll. This is often the case even when the only worker is the owner and the business is incorporated. The corporate enterprise must treat the owner as both employee and shareholder.

Computation of payroll taxes as well as other paycheck additions or subtractions is tedious and complex. Many entrepreneurs outsource the function to payroll services. A substantial number of business owners deploy internal computer payroll applications. These platforms commonly interface with the company’s general bookkeeping system. Unfortunately, this frequently leads to a false sense of security that accurate accounting for payroll is automatic.

Careful input of employee data and details for each pay date is a manual process requiring great care. Scrutiny of the resulting payroll reports is a crucial step to assure the correct amounts and types of payroll taxes are determined and remitted. Most importantly, diligent examination of the business’s financial statements is essential for assuring that the payroll data has imported accurately to the bookkeeping accounts.

Periodic comparison of payroll information to the business financial statements is the best procedure for averting payroll accounting problems. This examination necessitates having both the company balance sheet and income statement as well as the payroll data. The income statement should have an expense account showing the amount of gross wages paid before employee taxes and other deductions. The expense account for payroll taxes should indicate the employer’s taxes only. The balance sheet will have liability accounts for deductions from employee paychecks and the employer share of taxes.