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How To Prevent The Most Common Accounting Errors

How To Prevent The Most Common Accounting Errors

Do you find that your books are always messed up? You try so hard all year to keep everything up-to-date and organized just to find out your checkbook is unreconciled, revenues are duplicated, and all that time you spent tracking down and inputting receipts didn’t make their way into the ledger. You think your accounting system is syncing and importing everything with 100% accuracy so all that’s left to do at year end is tell the accountant the books are ready for tax prep. Unfortunately, you find yourself having to start over and end up telling your accountant to unravel the mess, all while trying to run a business.

It's a rather common scenario that I see all too often. Many business owners are shocked at year end that their accounting records are in the shape they are in. I also typically see that by the time it is all sorted out, records are too far into the following year to unravel. You then have to weigh the options of starting over from the beginning of the year or waiting until the end of the current year to start fresh. It's a vicious cycle that when you get caught in the motions, years go by faster and faster, allowing less time to “catch up”.

So how can you be proactive and alleviate those pesky accounting errors? Focus on the {workflow} . Focus on the daily transactions that are generated from your line of business. Each industry has a unique accounting method that is not a cookie cutter approach across all lines of business. Most businesses recognize revenues and process sales utilizing one of two workflows, a point of sale system (or cash register), or an invoicing system. Some businesses may utilize both methods if they provide various lines of service.

I have sectioned this article into two revenue recording methods, the first with a focus on point of sale driven businesses, and the second with a focus on invoice driven businesses. Each section describes the most common accounting errors I come accross and methods to help prevent them. Some topics will overlap, but if you find that your business utilizes both methods feel free to check out both sections. Otherwise, you may click the image above to take you to the respective section.


Section I

POS and Cash Register Businesses


Like most businesses that process revenue with a point-of-sale system or a cash register, your sales probably take place on the spot, face-to-face with your customers. You don’t send invoices or accept payments past the point of sale. You also probably don’t accept payments before hand either. You provide the good or service to your customer with the expectation of payment at the time of sale. The forms of payment include cash, check, or credit card.

If your business falls into this category, chances are you have run into some issues with setting up and maintaining accurate records. The top three accounting errors I have seen causing inaccurate records happen when:
    1. Recording point-of-sale records into your ledger
    2. Posting credit card charges and recording merchant processor deposits
    3. Managing and recording inventory adjustments
Each of these areas seem to cause problems for many business owners when trying to maintain their records. Let's look into each one and see how you can finally rid your books of those accounting errors.

Recording point-of-sale records into your ledger


Most stand alone cash registers do not have accounting system integrations likes some POS systems. They simply total your goods sold, apply sales tax, and record the customer's payment. Since your register is not talking directly with your accounting system, you will need to record your daily receipts manually. This starts with generating a daily cash receipts report, also known as a “Z Report”. When closing out your cash drawer at the end of the shift, your register will provide a summary of the daily sales and collections. This also acts as a way to be sure you register is balanced and the cash you have collected balances with the cash reported.

Once you have run the daily report, the next step is to enter the transaction directly into your accounting system. This is typically done through a journal entry and the description could be titled “Daily Sales Receipts XX/XX/20XX”. The journal entry will consist of sales, sales tax, and collections (Cash & Credit). This entry will balance (debits and credits) and could look something like this:

Date: 10/10/2016            Description: Daily Sales Receipts - 10/10/2016
                      Account Description                                            Debits                       Credits
                      Sales                                                                                                           ($2,500.00)
                      Sales Tax                                                                                                       ($160.00)
                      Cash/Check - Deposit in Transit                         $1,000.00
                      Credit Card - Deposit in Transit                          $1,660.00


This step is usually where the error takes place. Sometimes the journal entries are posted incorrectly, debits as credits or credits as debits. Also, I have seen business owners post the sales to the sales account as well as the cash collections to the sales account. Sometimes business owners will record the credit cards in transit as well as the deposit from the processor into sales, therefore duplicating sales and never seeing the errors on the balance sheet. It is important to be sure you have an accurate template setup and you stay current with recording your daily sales entries.


For some scenarios, newer accounting applications will tie in directly with your point-of-sale solution. It is important in this case that when you map your accounts, you be sure they are set up and aligned properly. Pay close attention to revenue accounts (sales) versus your asset accounts (cash or credit card collections). Also be very sure that when you finally record your deposit of cash or credit card processor deposit that they go against the deposit-in-transit account, and not the sales account. This will be very clear if you reconcile your checkbook frequently.


It is obvious there are advantages to having your POS systems integrate directly into your records but be very certain the data being retrieved is accurately mapped to the appropriate accounts. It is much harder to unravel a mess and start over than it is to take the time and verify your data imports.


This section leads me into my next area of trouble, credit card processing and deposits.


Posting credit card charges and recording merchant processor deposits


In today's course of business, not accepting credit cards is almost unheard of from a consumer point of view. We still have our local establishments that most locals know are cash only, but when new patrons or customers arrive not knowing, they frantically search for the nearest ATM, sometimes costing the business owner the revenue. For that reason, we see almost all establishments accepting some form of plastic payment, debit or credit. Despite the relatively high processing fees, business owners understand the necessity to accept various payment methods as a convenience for both the business owner and customers.


With the convenience as a business owner to rapidly process transactions and potentially reach a wider customer base, that could also lead to more headaches from an accounting standpoint. As mentioned in my first point, recording the sale from the POS or cash registers Z Report does not take into account the funds deposited into your checkbook. This entry records the amount that WILL be deposited in the future, hence the name “Deposit in Transit”.


It is extremely important that when you record the sale from a POS or register’s daily Z Report, that you follow the journal entry setup as seen above. The deposit in transit account can be thought of as a holding account that tells the ledger these funds are to be deposited into the checkbook. Though we have separate accounts for cash/check and credit cards, we frequently see errors arise when recording sales derived from credit card sales.


Depending on the arrangement you have with your processing company, some arrangements are setup to deduct the fees immediately and before the deposit into your checkbook, while some will deposit the full batch amount and withdraw the processing fees as a separate transaction at the close of the period. As some business owners like the fees to be deducted prior to the deposit, this can create a headache when reconciling your actual deposits to what was supposed to be deposited.


If your fees are withdrawn after your credit card deposit, the accounting system transactions should look like this:


Journal entry to record sale
Date: 10/10/2016            Description: Daily Sales Receipts - 10/10/2016
                      Account Description                                            Debits                       Credits
                      Sales                                                                                                           ($2,500.00)
                      Sales Tax                                                                                                       ($160.00)
                      Cash/Check - Deposit in Transit                         $1,000.00
                      Credit Card - Deposit in Transit                          $1,660.00


Checkbook deposit
Date: 10/10/2016            Description: Daily Sales Receipts - 10/10/2016
                      Account Description                                            Debits                       Credits
                      Checking Account                                                $1,660.00
                      Credit Card - Deposit in Transit                                                              ($1,660.00)



If your fees are withdrawn before your credit card deposit, the accounting system transactions should look like this:


Journal entry to record sale
Date: 10/10/2016            Description: Daily Sales Receipts - 10/10/2016
                      Account Description                                            Debits                       Credits
                      Sales                                                                                                           ($2,500.00)
                      Sales Tax                                                                                                       ($160.00)
                      Cash/Check - Deposit in Transit                         $1,000.00
                      Credit Card - Deposit in Transit                          $1,660.00


Checkbook deposit
Date: 10/10/2016            Description: Daily Sales Receipts - 10/10/2016
                      Account Description                                            Debits                       Credits
                      Checking Account                                                $1,600.00
                      Credit Card Processing Fees                                   $60.00
                      Credit Card - Deposit in Transit                                                              ($1,660.00)



It is important to notice that in both cases the deposit in transit account for both entries has a matching transaction amount. This comes in handy when reconciling your actual deposits to expected deposits.


So where do the errors occur? I have seen business owners post the checkbook deposit to sales (duplicating the original entry to record the sale), and not reduce the balance in the deposit in transit account. This will result in duplicating sales and a balance sheet that shows a duplicated undeposited cash account. For business owners that don’t reconcile their credit card deposits or view their ledger account balances, they find themselves thinking they have greatly overstated their sales, but still trying to find the cash that never showed up in their checkbook!


In the case where processors withdraw fees before the deposit, I have seen business owners that post only the net amount of the deposit (after credit card fees) and forget to record the merchant service fees. It is important to follow the journal entry sequence above. This will alleviate any chance that your undeposited account is not reconciled and that your merchant processing fees are accurately represented.


So in summary, follow these steps carefully if your business accepts credit cards and you are responsible for recording the daily transactions. And don't forget to reconcile your credit card deposits! This will greatly increase your chances of accuracy and provide you with error proof reports.


Managing and recording inventory adjustments


Last but not least for this section, inventory. Chances are if you utilize a point-of-sale system or cash register, you need some sort of inventory management system. Buying and selling any types of goods is a very tedious process and if not managed appropriately could become an unorganized disaster, quickly.


So if your business carries and manages inventory, where do I see the biggest mistake? Actually recording your inventory. Many business owners record their purchases but never adjust for inventory on hand. Now, this is not necessarily a major issue, however, if you find that you carry large amounts of inventory, your reports will never reflect your actual profit margins.


So how do I calculate my inventory and how do purchases fall into this equation? Calculating inventory is simple, yet sometimes tedious. First, inventory is always recorded at cost, not its sales price to your customers, but the price in which you purchase the goods from your suppliers. Next, start calculating! Setup a spreadsheet to record price and quantity and calculate away. Hopefully you already have something setup or some sort of history of what is on hand. It would also be great if you have some sort of inventory system that you can record inventory additions and based on what has been sold, see quickly how much you have on hand.


Next, let’s look at the cost of goods sold calculation. This calculation can be altered many ways to work towards any item. So, short and sweet:


Simple Inventory Calculation
                      Beginning Inventory                                                $5,000.00
                      (Plus) + Purchases                                                       $500.00

                      (Less) - Ending Inventory                                       ($4,900.00)
                      Cost of Goods Sold                                                      $600.00



Based on this simple inventory calculation, you can see that your cost of goods sold for the period was $600. Though your purchases on the books would show $500, you want to be sure you adjust for your ending inventory. If your total sales for the period were $750, your reported profit margin could be represented wrong. Without the inventory adjustment your gross margin appears at 33.33% and with the adjustment the gross margin appears at 20%.


How do I be sure my ending inventory is recorded into my ledger? By setting up beginning and ending inventory accounts. You can do this by setting up in your chart of accounts in the section of accounts for purchases, an expense called beginning inventory and an expense called ending inventory. Assuming you have an asset setup called, inventory, be sure at year end your inventory matches what you have on hand. Once you begin a new year, record the following entry to the newly created expense accounts:


Inventory setup
Date: 1/1/2017            Description: To setup inventory accounts
                      Account Description                                            Debits                       Credits
                      Beginning Inventory (Expense)                          $5,000.00
                      Ending Inventory (Expense)                                                                  ($5,000.00)


Note:

Be sure you make this entry to the newly created expense accounts, not the asset account. Why am I doing this? Well your net effect on the income statement is $0. Total debits equal total credits in this case. The true change comes at the end of the period after counting the inventory on hand. Hopefully this occurs monthly so you can retrieve accurate reports.

Based on the first entry, here is an example. You have counted that you have $5,500 on hand at the end of the month (after all your sales and purchases all month). You will record this adjustment at the end of every counted period to be sure your total inventory as an asset equals what you actually have on hand. So the variance from the beginning $5,000 to $5,500 is $500. Go ahead and a make the following entry:


Inventory adjustment
Date: 1/31/2017            Description: To record inventory adjustment
                      Account Description                                            Debits                       Credits
                      Beginning Inventory (Asset)                                 $500.00
                      Ending Inventory (Expense)                                                                    ($500.00)


When all entries are made, the ledger may look like this (for the related accounts, not all):


                      Account Description                                            Balance
                      Beginning Inventory (Asset)                                  $5,500.00
                      Beginning Inventory (Expense)                             $5,000.00
                      Purchases (Expense)                                                  $600.00
                      Ending Inventory (Expense)                                  ($5,500.00)



Now let’s go back to our cost of goods sold calculation based on this example:


Inventory Calculation
                      Beginning Inventory (Expense)                              $5,000.00
                      (Plus) + Purchases                                                       $600.00

                      (Less) - Ending Inventory (Expense)                     ($5,500.00)
                      Cost of Goods Sold                                                      $100.00



Based on this example you can see that your actual cost of goods sold was only $100, and not the previously reported $600 of purchases. This makes a big difference when reporting on net income and trying to get a true overview of how your business is doing. Now all of this obviously plays into cash flow and managing the purchase inventory, but be sure to follow these simple steps to promote reporting accuracy. Be sure to count inventory as frequently as the resources allow. If you find yourself in a chaotic mess, get a better POS system that can track inventory levels. I have used and like Shopkeep POS.


Now, on to section two, invoice driven businesses.

 


Section II

Invoice Driven Businesses



If you made it through section one and are still interested in this section because you invoice customers as well as using a point of sale system, grab a coffee and take a short break before this section. If you only invoice customers and skipped over the POS section, grab a pencil and a note pad and get ready to rid your books of accounting errors.

First off, let’s define this type of business model. You are the type of business owner that requires an invoicing system. You don’t process transactions on the spot like a hardware store or a deli. You provide some sort of service or professional output where you invoice your customers or clients for services rendered. Payment is not necessarily due on the spot, it typically requires payment by a due date. Payments are often made by credit card or check processing.

Many business owners that I have worked with who accept invoices run into similar accounting errors as those that process transactions by a point of sale system. The top three reasons I have seen inaccurate records are:

  1. Applying customer payments to invoices
  2. Accepting prepayments or retainers
  3. Posting credit card charges and recording merchant processor deposits

Each of these areas seem to cause problems for many business owners when trying to maintain their records. Let's look into each one and see how you can finally rid your books of accounting errors.

Applying customer payments to invoices


After providing the service to your customer or client, the first thing you will record into your accounting system is the invoice for services rendered. This invoice is a documentation that shows the customer’s profile, the services provided, rates and quantities of services, sales tax applications, total amounts due, due dates, and acceptable payment methods. All of this information provides your customers with a quick overview of what they received, and how and when to pay you. So where does the accounting error occur? When recording the customer payment.

Depending on your method of accounting, cash or accrual, you will have different methods of recording revenues and customer payments. However, when you setup your accounting system, the ledger account assignments still needs to be done correctly to alleviate any chances of accounting errors. When utilizing the accounts receivable system, most accounting systems require the setup and mapping of the accounts receivable related accounts. The most important account assignments are the accounts receivable account, the undeposited customer payments, and the unapplied customer payments.

Without the proper assignment of these accounts to the system settings, when processing transactions affecting these accounts your ledger will not accurately represent what actually occurred. In this case, the most frequent accounting error I see has to do with the applied customer payments step. Remember when using an accounts receivable system, there are three steps involved:

  1. Creating and sending the invoice
  2. Applying a customer payment
  3. Depositing the customer payment


So what is the proper setup of the assigned accounts involved with accounts receivable:

Accounts Receivable:                                                 Asset
Undeposited Customer Payments:                         Asset
Unapplied Customer Payments:                          Liability


The undeposited customer payments account is known as a deposit in transit account, or a holding account. This means the customer's payment has been received and recorded into the system but has not yet been deposited into the checking account. So how does the accounting error occur? The error occurs when the deposit into the checkbook is recorded against sales and not against the undeposited customer payments account. The proper way to do this would be to be sure to deposit the funds from the accounts receivable system.

To alleviate any chance of accounting error here, be sure to complete steps 2 and 3 of the three step system. Be sure to apply the customer payment to the appropriate invoice. Either in total or partial, the customer should always be able to retrieve an accurate customer ledger showing invoices and payments applied. You will want to be sure this is accurate. Also, never post a deposit to the checkbook that should be deposited through the accounts receivable system. Posting the checkbook deposit to anything other than the undeposited account could set you up for major reporting errors.

Accepting prepayments or taking retainers


Similar to the previous error causing event is the next culprit, recording deposits that are not being applied to an open customer invoice. The customer payment is not being applied to an open invoice just yet because they are considered prepayments for services to be rendered in the future. These deposits are considered liabilities to the company as they have not yet provided the services to the customer.

As shown above in the previous section, the unapplied customer payments need to be setup as a liability. This liability could also be thought of as a holding account for payments that will be applied to invoices in the future. Remember the 3 phases of the accounts receivable process.

  1. Creating and sending the invoice
  2. Applying a customer payment
  3. Depositing the customer payment


In this case we are skipping number one and starting with number 2, then 3, and on to 1. Be sure when creating the customer payment that it is created in the accounts receivable system.

If the deposit is not created in the accounts receivable system and just deposited into the checkbook, you set yourself up for two possible errors. One being that you are recording the deposit as revenue and not as a liability. And two, when you go to create the future invoice, you will not be able to apply the customer payment to the newly created invoice. Chances are the system will not notify you that you have a payment to be applied. If you do apply the payment manually, you may duplicate payments and in turn have an erroneous deposit on the books and a liability that is now earned.

So in the event you receive a customer payment as a prepayment or a retainer be sure to record the payment properly. Also, be sure to track your prepayments carefully as they may affect future cash flow (expecting payment for an invoice when you already received the money and spent it).

Posting credit card charges and recording merchant processor deposits


Very similar to the point of sale type businesses, this final error causing event is derived from accepting credit card payments.

As an added convenience for your customers or clients, many business that invoice their customers accept credit cards as a form of payment. This is especially convenient for subscription or recurring revenue modeled businesses. If you find that your business accepts credit cards continue to read on. Also, if you already read through the first section for POS driven businesses, this will be very similar to first section. It is that important to point out!

So, depending on the arrangement you have with your processing company, some arrangements will deduct their fees immediately and before the deposit into your checkbook, while some will deposit the full batch amount and withdraw the processing fees as a separate transaction at the close of the month. As some business owners like the fees to be deducted prior to the deposit, this can create a headache when reconciling your actual deposits to what was supposed to be deposited.

If your fees are withdrawn after your credit card deposit, the accounting system transactions should look like this (Accrual Basis):

Accounts Receivable System - Recording the Sale
Date: 10/10/2016            Description: Invoice #1234
                      Account Description                                            Debits                       Credits
                      Sales                                                                                                           ($2,500.00)
                      Sales Tax                                                                                                       ($160.00)
                      Accounts Receivable                                            $2,660.00

Apply Customer Payment
Date: 10/11/2016            Description:Payment Ref #9876
                      Account Description                                            Debits                       Credits
                      Credit Card - Deposit in Transit                         $2,660.00
                      Accounts Receivable                                                                               ($2,660.00)

Deposit to Checkbook
Date: 10/11/2016            Description:Deposit Ref #9876
                      Account Description                                            Debits                       Credits
                      Checking Account                                                $2,660.00
                      Credit Card - Deposit in Transit                                                            ($2,660.00)


If your fees are withdrawn before your credit card deposit, the accounting system transactions should look like this (Accrual Basis):

Accounts Receivable System - Recording the Sale
Date: 10/10/2016            Description: Invoice #1234
                      Account Description                                            Debits                       Credits
                      Sales                                                                                                           ($2,500.00)
                      Sales Tax                                                                                                       ($160.00)
                      Accounts Receivable                                            $2,660.00

Apply Customer Payment
Date: 10/11/2016            Description:Payment Ref #9876
                      Account Description                                            Debits                       Credits
                      Credit Card - Deposit in Transit                         $2,660.00
                      Accounts Receivable                                                                               ($2,660.00)

Deposit to Checkbook
Date: 10/11/2016            Description:Deposit Ref #9876
                      Account Description                                            Debits                       Credits
                      Checking Account                                                $2,660.00
                      Bank Service Fees                                                                                        ($60.00)
                      Credit Card - Deposit in Transit                                                            ($2,600.00)


It is important to notice that in both cases the deposit in transit account for both entries has a matching transaction amount. This assists when reconciling your deposits to expected daily charges.

So where do the errors occur? I have seen business owners post the checkbook deposit to sales (duplicating the original entry to record the sale), and not reduce the balance in the deposit in transit account. This will result in duplicating sales and a balance sheet that shows a duplicated undeposited cash account. For business owners that don’t reconcile their credit card deposits or view their ledger account balances, they find themselves thinking they have greatly overstated their sales, but still trying to find the cash that never showed up!

In the case where processors withdraw fees before the deposit, I have seen business owners that post only the net amount of the deposit (after credit card fees) and forget to record the merchant service fees. It is important to follow the journal entry sequence above. This will alleviate any chance that your undeposited account is not reconciled and that your merchant processing fees are accurately represented.

So in summary, follow these steps carefully if your business accepts credit cards and you are responsible for recording the daily transactions. This will greatly increase your chances of accuracy and provide you with error proof reporting.

Summary


Over the years I have seen many accounting mistakes. The six topics mentioned in this article seem to have been the most common and really stick out as the main culprits. The good news is, with a little effort they are not only relatively easy to fix, but you will also see accurate insight into your business leading to smart decision making. Smart decision making will result in a better managed, financially sound, long-term business model.

If you are starting a business and starting to setup your books, now is the time to properly install the right procedures so these accounting errors don't happen to you. If you are already running a business that you fear could be affected by some of these accounting errors, start by carefully evaluating your current ledger. If you don’t have the time, find your nearest professional and get back on track as quickly as possible. It could mean the difference between a profit and a loss.

Any questions or comments? Feel free to reach out.

 

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