Stan Snyder, CPA and expert bean counter
So you're ready to start using a computerized accounting program. Before you can begin creating invoices and writing checks, you need to create a company file with accurate vendor and customer balances, a complete list of products and services sold, and all the necessary financial account balances. Sound challenging? Well that's because it is. Yet, once you set up your accounting system, you can then realize all the benefits of accounting software: increased efficiency, ability to track, analyze and improve your financial health, and the opportunity to add services such as payroll and credit card processing.
I've used Microsoft Office Accounting as the accounting software for this task, but the principles apply to any accounting software package. Before you enter information into the software, you will need to assemble some data about your company. This article explains the basic information you need and how to best assemble it.
The five step process:
Determine your start date.
Assemble your business records.
Set up your financial accounts.
Verify account balances.
1. Determine your start date
The start date is a specific point in time that you choose. This should be a point in time that all of the financial account balances can be readily calculated. These balances are entered into the accounting program as a beginning point. No reports or detail of transactions will be available in the accounting system before the start date. After the beginning balances are entered, all transactions between the start date and the current date must be entered. The combination of these beginning balances and the subsequent transactions will accumulate to true, accurate current balances for all of your accounts — accounts receivable from customers, accounts payable due to vendors, bank accounts, credit card liabilities, as well as income and expense accounts.
Entering beginning balances as of the start date
When you calculate the beginning balances of accounts, you need to:
Calculate balances at a specific point in time — the start date.
Ignore payments received from customers after the close of business on that date.
Include amounts due to vendors as of the close of business on that date.
This means that all transactions — checks written, payments received, invoices created, and so on, summarized by financial accounts — up to and through the close-of-business on the start date are reflected in the balances entered as of the start date.
To calculate the balance of an account as of the start date, begin with a statement from a bank, vendor, or credit card company that summarizes a period prior to the start date. Add any transactions incurred before the start date that are not reflected on the statement, and subtract any payments made but not posted on the statement. For accounts receivable, summarize the charges and payments for each customer, up to and including the start date, to determine the balance outstanding as of that date.
Beginning balances must be calculated for each account in the chart of accounts: bank accounts, accounts receivable, inventory, fixed assets, accounts payable, credit card liabilities, notes payable, and equity accounts. If the start date is the beginning of a new fiscal year, income and expense accounts will be zero, but if the start date is in the middle of a fiscal year, income and expense account balances must be calculated as well.
2. Assemble your business records
Calculating and entering the bank balances, accounts receivable, and accounts payable constitute the majority of the work for most businesses. Setting up these accounts depends upon your situation. Does your business already exist or are you starting something new? Have you been keeping up accounting records or have things gotten a little messy?
Setting up a new business
It's easiest to set up an accounting system for a new business. New businesses begin with zero balances in all financial accounts, and the balances are generated by the entry of transactions. For a new business, the start date is the date of the first transaction, which is usually a deposit made to open a new bank account. Transactions such as deposits made or checks written are then recorded as they occur. Accounts may be created on the fly, as the need for them arises.
Converting from an existing system
If you have an existing business, and are converting from a manual system, your existing accounting system is a good source for beginning balances. With an existing business, you need to decide what date should be used to enter beginning balances and begin recording transactions.
Choose a date, usually month-end, and enter the balances from your old system as beginning balances in your new system. If you choose a recent date, you can reduce the volume of transactions to be entered between the start date and the current date. From the start date forward, all transactions must be entered in your new system. In Microsoft Office Accounting, no transaction details or financial reports will be available before the start date, however that information may be found in your old system.
Generating beginning balances from last year's tax records
If your current system is not as well organized as you'd like, your previous year's tax records are a good source for beginning balances, if your accountant prepared what is known as a "trial balance." Your accountant will have examined the accounts on the trial balance and will have adjusted for items such as depreciation and amortization.
Using these balances is a good starting point for your accounting system, but there is a trade-off if the current date is not close to the beginning of the year: Most small businesses use a calendar year for tax reporting, and all transactions between the start date and the current date must be entered before the accounting system can be used.
If the current date is late in the year, there may be a lot of data entry that needs to be completed before accounts reflect current balances. Selecting a start date that is closer to the current date means less data entry in the new system, but the data still needs to be accumulated and summarized to produce accurate starting balances. The best way to summarize data is in a database — which is exactly what an accounting software program is.
No system: Calculating balances from scratch
If you have no accounting system, or have been struggling with a check register and hand-written invoices, you still need to determine a start date and calculate balances as of that date from whatever records you have. A good place to start is with a reconciled checking account balance as of the start date. Begin with the balance per the bank, add deposits in transit (those not shown on the bank statement) and subtract outstanding checks (checks issued but not cleared). The Microsoft Office Accounting Setup Wizard will help you enter this beginning balance when creating your bank account.
Next, review amounts due from customers as of the start date. Include customer balances that were due on the start date but have since been paid. You will need these balances to record the subsequent payment receipts and deposits. As you create each customer record in the Microsoft Office Accounting Setup Wizard, you will have the opportunity to enter their beginning balance as of the start date. Similarly, accumulate all of the bills due to vendors as of the start date, even if they have been paid. You will enter these bills when you create vendor records. Checks written after the start date that pay bills outstanding on the start date will be applied to the vendor's balance rather than to an expense account.
3. Set up your financial accounts
You need to determine which accounts you want to have as part of your accounting system. All businesses have general ledger accounts — accounts that are used to summarize and categorize financial transactions. These are commonly referred to as "accounts" or "financial accounts," and are listed in your chart of accounts. Most software programs will recommend a standard chart of accounts. You may then add to the chart of accounts to accommodate special requirements for your business, such as separate revenue and cost of sales accounts for labor and materials.
The Microsoft Office Accounting Setup Wizard walks you through the process of creating financial accounts and entering beginning balances.
When you select a business type in the Company Setup Wizard, Office Accounting recommends a standard chart of accounts based on your business type, which is an excellent starting point. You can add or delete accounts from the standard list to suit your specific needs. After you choose which accounts will be part of your system, you'll enter opening balances for each of them. Remember, account balances for an existing business need to be calculated as of a specific point in time, usually the close-of-business on the last day of a fiscal period. You then create and enter balances for general ledger accounts, set up customer and vendor records, and enter inventory items, quantities, and costs.
After you select your accounts, review the following list to see if any of these accounts apply to your business:
Inventory of goods held for sale to customers.
Fixed assets: furniture, fixtures, equipment, and vehicles owned by the business
Other assets: patents, trademarks, copyrights, or start-up costs.
Business credit card accounts. (As with accounts payable, calculate the balance due as of the start date, not the current date. Begin with the most recent credit card statement prior to the start date; add any charges before the start date that are not reflected on the statement, and subtract any payments made but not posted on the statement to get the balance due as of the start date.)
Balance due on a business line of credit.
Sales taxes payable.
Payroll taxes payable.
Notes payable to banks or other creditors.
When placing a value on inventory, fixed assets or other assets, the actual cost should be used. If the asset has depreciated, the lesser of cost or current market value should be used, but appreciation on assets is not recognized until the asset is sold. Liabilities are valued at the amount owed as of the start date. Using the Microsoft Office Accounting Setup Wizard, you can calculate and enter these account balances as of the start date you chose.
What about the equity accounts? I haven't discussed equity account setup, but entering accurate asset account balances will increase your equity, and entering accurate liability accounts will decrease your equity. Office Accounting uses the equity account Open Balance Equity to track changes in equity as the asset and liability accounts are created. You can be confident that if your asset and liability accounts are accurate, your equity balance will be correct. Your accountant may want to reclassify the opening balance equity into accounts like Paid in Capital or Retained Earnings, but total equity will be left unchanged.
4. Enter transactions between the start date and the current date
This is where the fun begins: entering transactions. Since you've carefully calculated your beginning balances, this should be easy. The process of entering transactions is centered on the bank account, since virtually all transactions eventually affect the bank account.
Enter transactions month-by-month, taking time to reconcile your accounts at the end of each month.
Create invoices and record payments received against those invoices or beginning customer balances, then make the deposits to the bank account.
Enter bills, payments made on accounts payable, and record checks written out of the bank account.
Use your vendor statements to enter finance charges and verify that your balances agree with your vendors' balances.
As you complete each month, reconcile your bank statement, credit card, and vendor account balances to verify that all amounts have been recorded accurately.
5. Verify account balances
After entering all transactions through the current date, verify that all of the account balances reflect real-world amounts by comparing them to external sources. Reconcile the bank account to your bank statement (this should be done every month); verify the credit card liability to your credit card statement. Notes payable may be verified by comparing to a loan history or loan statement from your bank. Accounts payable may be verified to vendor statements, and sending accounts receivable statements to customers will help to verify receivable balances.
On an ongoing basis, the verification steps mentioned above — reconciling all of the balance sheet accounts to external sources — will insure that your data remains accurate and help you to find and eliminate errors. Reconciling the balance sheet accounts — assets, liabilities and equity — on a monthly basis will make year-end reconciliations "just another month," and will make assembling information for your tax accountant quick and easy.
Now that you have correct balances for all of your financial accounts, you are ready to begin using your accounting system — you have a good foundation for future transactions. Data entry will be easier — and make more sense. Accounts payable will reflect the correct amounts owed to vendors, and accounts receivable will show correct customer balances. Financial reports will show correct balances for asset, liability, equity, revenue, and expense accounts and will reflect the true results of operations. The account balances will also agree with your tax returns for the previous period, making your tax accountant happy while keeping the tax auditors at bay.
About the author
Stan Snyder is a certified public accountant with over 25 years experience dealing with the accounting and computer problems that small business owners face. He teaches computerized accounting classes at Colorado Mountain College, and regularly consults with small business owners using accounting software of all types. If you have questions about this topic or another accounting topic, send Stan some feedback by responding to the question below "Was this article helpful?" Stan may use your questions or topic ideas in an upcoming column.