May 25, 2023

9 Common Bookkeeping & Accounting Errors Small Businesses Should Avoid

From not recognizing revenue and expenses when they are earned to failing to keep accurate records, learn what mistakes you should look out for, for your Altoona IA small business.

Managing financial operations can be a daunting task.

There are many financial responsibilities that must be taken care of.

While it can be tempting to take on these tasks yourself, mistakes can be costly to the business.

In fact, some mistakes can be so serious that they can lead to financial problems or even bankruptcy.

That's why it's important to work with a CPA or a highly technical tax accountant who can help identify potential mistakes and provide guidance on how to avoid them.

Learn how to manage your finances effectively and avoid costly mistakes.

We'll explore some of the most common financial mistakes small business owners make to inform you on how to avoid them for your business.

9 Common Bookkeeping & Accounting Errors Small Businesses Should Avoid

Accounting Fail #1 - Incorrect Allocation of Indirect Expenses

Indirect expenses are costs that a business spends that are not directly associated with the production or sale of goods or services.

Typical examples of indirect expenses include utilities, insurance, and office supplies.

Failing to distribute indirect expenses can lead to skewed financial reporting and distorted cost analysis.

If a business owner allocated all rent expenses to a specific product, even though the rent applies to the entire operation, it would give the impression that the product is less profitable than it truly is.

It is important to distribute the indirect expenses upon the entire business.

Accounting Fail #2 - Incomplete or Incorrect Form 1099 Reporting or classifications

When you hire someone, they are either a W-2 employee, or a 1099 contractor.

If you pay someone, you'll need to file the proper documents.

If you have payments to people that are unsubstantiated, and you don't report them properly, you're going to be open for liability.

You might end up having payments reclassified, and you'll owe taxes & penalties.

You also need to ensure that contractors meet the requirements to be classified as 1099 sub contractor, not a W-2.

If you get this wrong, you'll end up creating headaches for yourself.

We recommend connecting with our team & ensuring you're obeying the rules here.

Failing to provide Form 1099s to eligible contractors or supplying incorrect information can result in IRS penalties and potential audits.

For instance, if a business owner neglects to distribute a Form 1099-NEC to a contractor who earned more than $600 during the year, they could be penalized for noncompliance.

Accounting Fail #3 - Capitalizing vs. Expensing

You don't get to write everything off right away.

If your purchase is over $2,500, chances are you'll need to capitalize that purchase, and write it off over the long haul.

That means you'll usually write off a small piece of it over a couple of years.

The temptation is to expense the whole purchase, and take the write off all at once.

You need to get this right.

If you make a mistake and write off that purchase without capitalizing, you're setting yourself up for an audit and problems in the future.

Incorrectly classifying capital expenditures (e.g., equipment purchases) as immediate expenses or vice versa can have a major impact on financial statements and tax liabilities.

For example, expensing a major equipment purchase instead of capitalizing and depreciating it over time can artificially decrease net income and taxable income in the present year.

We help growing businesses determine if they need to capitalize or expense a purchase.

Accounting Fail #4 - Overlooking State and Local Tax Obligations

As cities and states add unique sales taxes, income taxes or other bureaucracy, it's important that business owners carefully follow the rules.

If you collect sales tax when you shouldn't, or if you don't collect tax when it was due, you'll be open to significant liability and disruptions to your business.

In other words - you're open to get audited, and once theres' blood in the water, additional scrutiny will come your way.

Failing to adhere to state and local tax regulations, like sales tax, franchise tax, or property tax, can cause extra liabilities and penalties.

For example, a small business owner who sells items online may not be aware they have economic nexus in other states and therefore need to collect and pay sales tax in those areas.

Accounting Fail #5 - Not Understanding or Utilizing Carryforward or Carryback Provisions

Carryforward and carryback are tax regulations that permit a business to utilize current losses or credits to balance out previous or future taxable income.

If a business experiences a loss in a particular year, it may carry that loss forward to balance out future income and decrease taxes owed in subsequent years.

Similarly, if a business has surplus credits in a given year, it may carry them back to offset taxes already paid in previous years.

It is critical to comprehend or utilize these provisions may result in a business losing potential tax savings and potentially paying more taxes than required.

Accounting Fail #6 - Misapplying Tax Credits or Incentives

Incorrectly applying tax credits or incentives to a small business implies that the company is either not utilizing all eligible credits and incentives or using them inappropriately.

The intention of tax credits and incentives is to assist businesses in conserving money and minimizing their tax responsibility.

However, if a business doesn't identify all credits and incentives available or applies them erroneously, it could lead to overpayment of taxes.

Small business owners must comprehend the qualifications and regulations for each credit or incentive they may be eligible for and utilize them accordingly.

Accounting Fail #7 - Misclassifying Employees as Independent Contractors

Accurately classifying workers is crucial because it affects their lawful rights, benefits, and tax responsibilities.

If a business erroneously categorizes employees as independent contractors, the government can hold them accountable for overdue taxes and penalties, involving back taxes, interest, and fines.

Moreover, the business may encounter legal action by the incorrectly categorized employees for lost salaries and benefits.

Therefore, it's crucial for small business owners to identify the differences between employees and independent contractors and to appropriately classify their workers from the onset.

Accounting Fail #8 - Not Recognizing Constructive Receipts

Not recognizing constructive receipts refers to the mistake of not reporting income that has been made available to a business, even if the business has not yet received the money.

For example, if a client sends a payment to a business, but the business doesn't deposit the check until the following year, the income should still be reported in the year the payment was received.

Failing to recognize constructive receipts can result in underreporting of income, which could lead to penalties and interest from the IRS.

Accounting Fail #9 - Not Applying the Accrual Method Correctly

The accrual method is a way to record income and expenses for a business.

It recognizes income and expenses when they are earned or incurred, regardless of when the money actually changes hands.

For example, if you sell goods to a customer on credit, you would recognize the sale when it is made, even though the customer has not yet paid you.

This is different from the cash method, which only records income and expenses when cash changes hands.

It's important for small businesses to apply the accrual method correctly to accurately reflect their financial position and avoid errors in their financial statements.

Conclusion

To avoid costly errors, small business owners should keep accurate and organized records, stay up to date on relevant tax laws and regulations, and seek professional help from a Certified Public Accountant (CPA) or specialized tax accountant.

Doing so will help ensure your financial operations are compliant, accurate and optimized for success.

Make sure your business is on track for success - contact Performance Financial to schedule a consultation.

Our team of experts can provide insight into your financial operations and help you identify and correct any mistakes in your records, ensuring compliance with tax laws and regulations.

Don't let errors stand in the way of the success of your business - get in touch today to learn how we can help you stay on top of your finances.

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