Surefire ways to stress-less and work more quickly when trying to decide how to categorize your operating expenses.
One of the most consistent items I see business owners struggle with is the attempt to categorize their expenses to the “right” account. Now when I talk about account, I’m not talking about your bank or credit card account. I’m talking about your General Ledger Account, aka your Expense Accounts, as well as any other accounts you may have in your Chart of Accounts.
Many accounting software programs will ask you a little bit of information regarding your business when you are getting set up in the system. This is because they want to help set up a Chart of Accounts that contains categories most likely used by your type of business. This is much easier than trying to create a Chart of Accounts by scratch, but can cause confusion when business owners don’t understand what is supposed to go into each account.
So what do you do when you order a box of business cards? Do you put the expense in Advertising and Promotion? Does it go into Office Supplies? The answer is surprisingly simple. It goes where you want it to go.
In many cases, as long as an expense is an ordinary and necessary business expense, the business owner can decide how to categorize it without the IRS giving much concern. That might just help you breathe a little more easily and assign those categories more speedily knowing that the wrong account won’t necessarily ignite an audit and penalties. It isn’t a perfect science and private companies don’t have all the regulation that public companies have. So be consistent, but keep moving forward with your best guess.
So why all the accounts? Why not just set up three accounts, such as Expense – Fully Deductible, Expense – Partially Deductible, and Expense – Not Deductible? For starters, the Schedule C does ask for more detail, so it will be easier to fill that out completely when you have them categorized. Secondly, and most importantly, you will be given a clearer picture of what your business is doing by being able to see how much you are spending in each category. If you are seeing a low cash flow or net profit, you will have a tool you can go to in order to accurately see what is eating up that margin. This allows you to make corrections before it has a major impact on your bank account.
There are some exceptions where more accurate bookkeeping is required. For example, if you live in WA state and you get a travel reimbursement from your clients, you will want to make sure that hits a reimbursement income account and not assigned against Travel. This is because for B&O tax, you have to report ALL your receipts, even the reimbursements, as income. Additionally, just because it is on your Chart of Accounts, does not mean you can deduct it. I have seen many clients put their gas receipts for their personal vehicle on the books, just because the account was there. A personal vehicle has specific IRS rules that determines how much of it is deductible. And no, taking the family out to dinner, does not get assigned to Meals & Entertainment. Remember that for it to go on the books, it must first satisfy the ordinary and necessary business expense requirement mentioned above.
A bookkeeper or accountant may be able to help you determine what category an expense should be assigned to, if you are not sure or when a transaction is more complicated. Lighthouse Ledgers provides consulting and training for business owners, as well as bookkeeping services for those that want to offload those tasks. Feel free to reach out to us for any assistance we may be able to provide!
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Christina Young is a professional bookkeeper based out of Seattle, WA. Her business, Lighthouse Ledgers, is focused on helping small business owners spend less time on bookkeeping so they can spend more time on the things that matter in their lives.
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Disclaimer: Articles are educational only and based on opinion, experience, and research. This is not to be interpreted as legal, tax, or financial advice. Please consult with the services of a professional tax advisor, financial advisor, or legal advisor before making important business decisions.