Common Accounting Mistakes That Can Cause Serious Trouble
Like most things, accounting is easy when you know how. The trick is to get your accounting system working correctly from the outset, because systematic accounting mistakes that run undetected for months, or even years, can cause your business to lose money.
Your accounts give you basic information upon which you make decisions, such as “What are my sales?”, “How much money is in the bank?”, ”How much money am I owed?” or “Am I making a profit?”. If your accounts are not giving you the right answers to these questions, you will make the wrong decisions or simply not earn the return from your business that you should have.
# 1. Balancing your bank accounts
Most people use software for their accounts. This leads them to believe, mistakenly, that their books will be “balanced” and correct. This is simply not the case. You have to actively reconcile your bank accounts to ensure that all the transactions you have entered are complete and accurate. This applies whether or not you use software, spreadsheets or even manual books.
Let’s suppose that you paid your insurance company $700, but you entered this in your books as $7,000 without noticing it. Your bank statement would show a payment of $700, but your books would show a charge of $7,000, which is an overstatement of $6,300. If you don’t routinely check your bank statement against the transactions that you actually entered, it is highly unlikely that your accounts will be right. Even experienced bookkeepers make occasional mistakes.
# 2. Your customers
Many businesses issue sales invoices to their customers. Customers normally take one or two months to pay invoices, and when they do pay you, they pay you for one or more invoices at once. You need to pay careful attention to late payers, for a variety of reasons. It can indicate that:
- your customer is in financial difficulty if they have become slow payers, or
- your customer may be disputing your invoices. This can signal that you have a problem with the quality of your goods and services, or that your invoicing procedures just simply aren’t up to the mark and you aren’t invoicing your customers accurately. Either way, disputed invoices often don’t get paid. The longer a dispute goes on, the less likely you are to get your money.
You need to check your customer statements at a minimum every month, before you send them out, to make sure that they are accurate. If customers aren’t paying up, you need to know why.
# 3. Your purchase invoices
Every single purchase invoice that you put into your books should be checked first of all. Did you actually receive the goods or services invoiced? Is the data correct? Are the prices right? If there is tax on the invoice, such as VAT or Sales Tax, is that correctly shown? Does the invoice add up?
Related Post: Help Prevent VAT Fraud – Get Your Invoices Right
You might think it’s crazy to check these things, because everybody’s computerised right? Well, computers do what humans programme them to do and humans are often wrong. I once saw a supplier overcharge by about £100,000 on one single invoice. There was no malice intended, but the supplier had a bespoke invoicing system written especially for their business. Unfortunately, they did a poor job of checking their new system. The total on the invoice actually included the value of the invoice reference number. These are the types of errors that you are unlikely to find, unless you actually check. Laziness and complacency carry a high price.
# 4. Your suppliers
You need to check your supplier accounts every month against the statements that they issue to you.You may find that you’ve left invoices out of your books. It could be as simple as a paper invoice falling down behind a radiator or being misfiled, so you haven’t entered it into your books yet.
The list of potential accounting mistakes is endless. You could have marked a payment off against the wrong supplier, be due a credit note, or have entered an invoice twice. The truth is, unless you have a system of checking your supplier accounts, you will have mistakes. You will end up paying for goods and services that you never received or overpaying for something.
# 5. Your sales
The sales in your accounts is not always simply:
- the value of your sales invoices, or
- what went through your cash register,
- or the total in your online sales cart.
When you set up your business, you actually need to define what your sales are and how they are to be accounted for. Here are a few examples of what you have to consider when you are accounting for your sales:
a) You have to consider whether or not you are acting as a collection or booking agent in which case your income is commission, and not the full value of a sale. Let’s say you take holiday bookings for holiday homes over the internet. The holiday home owners are small businesses, who don’t have online processing facilities, so you collect all of the money on their behalf. The customer might pay $500 and you pay $450 to the holiday home owner, and keep $50 in commission for yourself. In this case, your sale is $50, and not $500. In the off-line world a similar situation arises in relation to the vending machines that you might have on your premises. Here, you simply provide a venue and customers, someone else provides the goods. If you don’t get this right you will end up overstating your sales, and it will probably have negative implications for your sales taxes as well.
b) If you are a bakery, your sales are baked goods. If you sell a delivery van, that’s not part of your sales, that is a sale of one of your assets, and it needs to be treated differently. This is a common occurrence in business.
c) Some services are sold on a time basis, and so sales must be taken into the accounts over the time to which those services relate, and not simply all at once. This applies to SaaS, (Software as a Service), companies as well as to subscription-based organisations.
Related Post: Why SaaS Revenue is Different
Sales are easy to record once you have established the basics of what you are selling, to whom and when. Once you have this right at the outset, it is easy to set up a system to record sales correctly. Every business is different, yet it takes no more than a few hours to sort these matters out at the outset.
# 6. Foreign currencies
If you have a bank account denominated in a currency other than your own currency, or if you buy or sell goods in another currency, then you need to to know how to account for foreign currencies. In reality, this is best done by having accounting software that will do this automatically for you. Ignoring foreign currencies is simply not an option if your business deals in multiple currencies.
For example, if you are an Irish business, and you have a sterling bank account, you can’t simply post the transactions that go through the Sterling bank account into your accounts as if they were in Euro. If you pay for something that costs £1,000 sterling, then it’s going to cost you somewhere in the order of of €1,200.You can’t simply record that as being 1,000 and let it be added into your accounts as €1,000. You would be massively understating the value of your expenditure if you did so. Your accounts would be quite meaningless.
If you are an Irish business, and you export and invoice in foreign currencies, again your software package needs to be able to handle this. Let’s say you invoice a customer for £1,000 sterling. On the date of the invoice, you should convert the invoice value to Euro in your accounting system, yet your customer account needs to be held in sterling. The exchange rate on the date of the invoice, might value your sales invoice at €1,180. If, when your customer pays you, you actually receive €1,200 the €20 difference is recorded as a foreign currency exchange difference in your accounts. It’s as simple as that.
# 7. Stock
If your business has a stock of trading goods, you have to count and value your stock at the end of every accounting period. The reason that you do this, is that you don’t sell everything you buy straight-away. You must reduce your cost of sales by the amount of stock that you have left over to sell in the next accounting period.
Here are some of the common accounting mistakes made in relation to stock:
- the stock count isn’t right. Goods are either not counted at all, counted twice or quantities are just recorded wrongly.
- the goods aren’t valued properly.
- the goods are obsolete, and your customers don’t want them. If this is the case, you should write your stock down to zero, because it has no value to your business.
If for example, you are a shoe retailer, obsolete stock is a fact of life. No shoe retailer ever sells all of the styles that they stock, because they are a fashion item. Therefore shoe retailers routinely write off obsolete stock. If you know that your customers aren’t even going to pay cost price for your goods, then you have to write your stock value down below cost straight away.
# 8. Research and development expenditure
Companies are allowed to show Research and Development expenditure on their Balance Sheet as an asset,(i.e. to capitalise this expenditure), instead of charging it as an expense account against profits, if that Research and Development expenditure will yield value into the future.
Software companies often classify the cost of their development staff as Research and Development, (R & D). They may have have a choice to either capitalise it (in the Balance Sheet), or write off this expenditure immediately against profits. It is usually better, in the long run, to take the hit for this type of expenditure immediately against your profits. Then, when your company starts to sell goods or services on foot of this research, you can show profitability then, because you have taken account of the R & D already.
It’s worth noting that the tax treatment for R & D expenditure, can be separate and different to the accounting treatment. As with all matters accounting don’t let the tail wag the dog. Do the right thing for the accounts first of all, and work out the tax afterwards.
# 9. Cash
Cash needs to be controlled very tightly in the business. It’s very easy to accidentally give too much change, miscount or lose cash. Obviously, it’s also very tempting for thieves. If you have cash, it should all be put through the tills on every shift, and tills should be balanced every shift without exception. Some businesses like to place cameras over the tills, which discourages theft and can be used to settle disputes in the event of the wrong change being given.
Not all businesses have tills, but if you handle cash, you need to have an independent way of recording and controlling it. You should set up control procedures in conjunction with your accountant from the outset. Otherwise, you risk losing money, literally.
# 10. Entering transactions twice
It’s easy to enter a transaction twice. You will probably never notice this, unless you reconcile your accounts each month. The outcome of entering a transaction twice is that you either overstate your sales or your purchases and your accounts don’t reflect what actually happened. This can lead you to pay a supplier too much money, to hassle a customer for the wrong amount, or for you to overpay taxes. None of these outcomes is a good one for your business.
Let’s take the example of the bank reconciliation again. For those that do prepare bank reconciliations, your bank account can in fact be balanced, but still be wrong. Every time you enter a payment into your books, the bank account balance in your books is reduced. However, there is often a timing difference between the date of issue of a payment and when it clears through your bank account. These are known as “outstanding items”, which need to be reconciled.
You could for example, put a payment into your books for a new telephone system for $5,000. You go to lunch, come back, lose your place, and put the same $5,000 into your books for a second time. At the end of the month you reconcile the bank account in your books to the bank statement, you see one payment for $5,000 going through on your bank account, and you ‘tick’ or mark that off as being right. However, the second $5,000 is shown as an outstanding item on your bank reconciliation, because it’s a payment that never actually happened. It’s never cleared through your bank account, and it never will. Now your books will show that your telephone system cost you $10,000 because you put the payment of $5,000 through twice. Your bank accounts are reconciled yet your books are wrong.
You need to review bank reconciliations at the end of every month to make sure that there are no old outstanding items that need to be corrected or written off. In this case, you would simply delete the second payment, because it never happened.
# 11. Closing your accounts
Your accounts are for a defined period. That could be a month, a quarter or a year. You have to ensure that all the transactions relating to the period are recorded accurately once and once only. Accountants call this process ‘cut off’.
Imagine if you had outsourced some web development. Your supplier sends you an invoice for $10,000 by email. However, the email goes into your junk box and you don’t see it, so you don’t put it into your accounts. Just because you haven’t seen an invoice, doesn’t mean that your business is not liable for that expense. In this case your accounts would obviously be wrong, because they would not include the cost of the €10,000 worth of web development.
Every time you do do a set of accounts, you have to look for missing items. If you don’t actively look for goods and services received but not invoiced, your accounts will be incomplete. That is why it is important to reconcile your bank accounts, your customer accounts and your supplier accounts every accounting period.
# 12. Spreadsheets
Spreadsheets were not designed to replace accounting software. Lots of people use spreadsheets to save money on accounting software. It is a false economy. People commonly put expenses in the wrong columns, and get the formula wrong in a variety of ways so that the spreadsheet simply doesn’t add up. Accountants often mask these accounting errors because they redo their clients books, unbeknownst to the client. However, sometimes the mistakes go unnoticed.
For example, if you are using a spreadsheet to calculate your VAT liability and your formula doesn’t include the VAT on all your invoices, you’ll simply underpay the VAT. People often don’t have the accounting and spreadsheet skills to find their own errors. Even if you are are a whizz at spreadsheets, they are highly inefficient for keeping your books. It’s a bit like using a thimble to empty a wheelbarrow.
# 13. Read your accounts
When your transactions are put into your books, you should go through every account to make sure that they make sense to you. For example, if you were a cloud computing provider, you might find that a bookkeeper would put Amazon storage costs into computer expenses, when in fact it’s a cost of sale, because you are providing a service involving cloud storage. If you were just archiving records onto Amazon, it would be would be correct to analyse that cost as a computer expense.
# 14. Legal requirements
You are obliged to keep proper books of account for legal reasons. This applies the world over. At a very minimum, businesses are expected to keep good accounting records so that they can correctly calculate and pay their taxes to the government. It is a sad fact of business that you are an unpaid tax collector. Such is life. If you operate through a company, the company is obliged to keep books and records that show a true and fair view of the state of affairs of the company. There are fines and penalties levied against companies who do not comply. Proper accounting is a requirement of being in business.
# 15. Consistency
You should analyse your expenses on a consistent basis, or else your accounts will become meaningless and have no managerial value to you. You shouldn’t analyse licenses under “legal expenses” in one year, and under “subscriptions and licenses” in another. This would make it impossible to draw comparisons between one year and another. Many accounting packages provide assistance for standardising the analysis of your accounts, and you should learn the functionality of your accounting package to make consistency an easy task.
Make accounting mistakes history
The issues outlined above are all solved by using a systematic approach to your accounting records. This post doesn’t cover every error that is possible, but it should give you an idea of how easy it is to make accounting mistakes, but yet how easy it is to prevent them from happening in the first place.
Every business needs to have a systematic approach to the to their accounting, so that little accounting errors don’t add up to big losses. Once the system is set up, the routine of maintaining it is quite easy. You should always consult with your accountant when setting up your accounting system, to make sure that your system is tailored to best suit your needs.
What accounting problems have you encountered in your business?
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