Don’t forget about these basic year-end adjustments
You’re gathering information for your tax return but before you finalize it, let’s chat a bit about a few important, and simple, adjustments. Whether you’re preparing for a personal income tax return (unincorporated business) or corporate income tax return, there are a couple of steps to:
- more accurately show the financial performance of your business, and
- ensure your financial information is reported using the required accounting method.
What are the accounting methods?
There are two main accounting methods:
cash
accrual
What is the difference?
Quite simply, cash-based accounting involves recording transactions when cash is received and paid; there are no accounts receivable or payable. While this method clearly shows the cash flow for your business, it doesn’t provide a good indication of longer-term profitability because your financial results are based on the timing of payments.
Accrual-based accounting involves recording revenue when it is earned and expenses are matched to the related revenue and/or recorded when they are incurred. This results in an income statement that better measures the profitability of your business. The accrual method is also required by the CRA (unless you’re a self-employed commission sales agent – see CRA accounting methods).
Most small businesses use a hybrid approach throughout the year. Accounts receivable tracks unpaid invoices (accrual) but expenses are recorded when they’re paid (cash).
What does this all mean?
The CRA requires accrual accounting which means a few things may need to be adjusted on your financial statements to ensure the information is reported using the required method. The most common areas are:
revenue:
deposits/retainers: did you record client prepayments as revenue but have not provided any services? If so, these amounts may need to be moved to the balance sheet as deferred revenue.
expenses:
bills/vendor invoices: in the month or two following your year-end, did you pay bills for expenses relating to your prior fiscal year? Check the service date/description on documents relating to expenses such as payroll, utilities, franchise royalties, and professional fees to determine if they need to be recorded as accounts payable/accruals.
Final Thoughts
Adjustments will depend on your business/industry and how your transactions have been recorded. Your accountant can assist you with this process to ensure the financial statements for your business capture the necessary transactions and accurately depict the financial performance of your business.
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