QuickBooks is a powerful tool for small businesses. Like any tool, it has qualities that are both useful and dangerous. The chief danger lies in depending too much on the program to perform all the work, without verifying information along the way or during year-end audits. Maximizing successful use of QuickBooks requires careful scrutiny for errors in the data. Fortunately, QuickBooks accommodates review of input with many useful reports. Though the sheer quantity of reports may seem daunting, users must closely examine the information in QuickBooks. Conducting this process at the end of each year is not difficult if you know what to look for, and how to evaluate these useful year-end tools.
A successful year-end closing in QuickBooks involves reconciling and verifying the figures representing the condition of the business. Begin with the balance sheet. Like any true accounting system, QuickBooks uses double-entry bookkeeping. This system is what maintains the balance of accounts on the balance sheet.
The net profit, derived from revenue and expense accounts, for your year-end analysis is reflected at the bottom of the balance sheet as an equity account called ‘Net Income’. The combined profit of past years is in the equity account called ‘Retained Earnings’. You’ll have some other equity accounts that depend upon whether your business structure is a corporation, proprietorship, or partnership.
Uses of profits are reflected as assets accounts at the top of the balance sheet. These are bank accounts, inventory, equipment, accounts receivable, and other assets. You may also have liabilities accounts representing borrowing to acquire some of the assets. The result of all this is that the balancing equation in double-entry bookkeeping is assets equal liabilities plus equity.
Your job at year-end is to make sure the balances are correct in the assets accounts and the liabilities accounts. All of these are verifiable against sources other than QuickBooks. QuickBooks provides a reconciliation feature to make sure that the balances in bank accounts match bank statements at the end of the year. This feature also is used to analyze the balances in credit card accounts and assure that they match credit card your statements.
You should analyze QuickBooks balances in accounts for bank loans by contacting your bank prior to the year’s end. If your business carries an inventory of goods for resale, you must conduct a physical count near year-end. The cost of inventory items on hand has to match what your QuickBooks balance sheet indicates for the inventory account. Make sure that assets you acquired during the year are additions to asset accounts, not recorded as expenses. Have separate accounts in QuickBooks for each type of asset for your year-end analysis – computers, machinery, office equipment, and improvements to real estate.
Most small businesses use the “cash basis” of accounting. This means that income is only counted when it’s collected, not when you send an invoice, and expenses only count when you pay them, not when you receive a bill. Your tax return indicates if you use the cash basis. If it does, select reports in QuickBooks that are cash basis. Instead of having to click on the ‘Modify Report’ button for every report, you can select cash basis as a company preference on the reports section of the QuickBooks “Preferences” menu to facilitate your analysis each year.
A cash basis balance sheet will not have any balances for accounts receivable or accounts payable. Obviously these accounts are only applicable for “accrual basis” accounting, which records income when you invoice for it and expenses when you’re billed for them.
Even if you use accrual basis accounting, take a look at the cash basis balance sheet in QuickBooks just to assure that there are no balances for accounts receivable or accounts payable. If either of these accounts have balances on the cash basis balance sheet, there’s an error in a QuickBooks entry. Whether you use cash basis or accrual basis, these errors are causing incorrect reporting of income or expenses.
Remember, you want cash basis income to analyze only what you put in the bank account, not accounts receivable. Likewise, you want expenses to be only those that are paid from the bank account or maybe a credit card account, but not accounts payable.
By far the most commonly misreported details in QuickBooks involve payroll. The best way to have your accounting records in QuickBooks match actual payroll transactions is to use the special QuickBooks payroll module. This allows accurate recording of gross wages and payroll taxes on both payroll reports and accounting reports, which makes end of year analysis much easier.
Without this companion system, you’ll have to verify that you’ve captured in QuickBooks the correct amounts for payroll transactions during each year’s analysis. For example, gross wages expense in QuickBooks should match actual gross wages, not net paycheck totals. Payroll taxes expense in QuickBooks is only the payroll taxes paid from funds of the business, not amounts withheld from wages. Compare the gross wages and payroll taxes in QuickBooks to amounts reported on quarterly payroll reports.
Don’t forget to check the accrued payroll taxes on the balance sheet. Even a cash basis business is entitled to deduct payroll taxes that accrue on payroll days. The accrued payroll taxes on the balance sheet should match what you will pay when due to taxing authorities, particularly the IRS. The amount is both the taxes withheld from employee wages plus the payroll taxes assessed on the business.
If accrued payroll liabilities on your balance sheet don’t match figures from recent pay dates, then past payroll tax payments have been incorrectly recorded in QuickBooks. All payroll taxes should be accrued on the balance sheet as liabilities and all payments should apply to that accrual, not to any expense accounts.
Make note of any discrepancies between QuickBooks and other sources of account balance verification found during your analysis. Common mistakes are easily corrected if you’re proficient with QuickBooks. If there’s any question about how certain problems were created or how to correct them, you may have a misunderstanding about QuickBooks and you benefit from professional assistance to make accounting adjustments and provide QuickBooks training. Lastly, wait to make adjusting entries for depreciation and amortization when figures are provided by your tax return preparer.
About the Author
David Heistein, CPA
Dave is co-founder and managing partner at Profitwise Accounting. Dave is a Certified Public Accountant in the state of California, as well as an advanced QuickBooks Pro Advisor and Instructor. As a small business owner, he is dedicated to educating and informing other business owners on bookkeeping and accounting matters.