How to Do Accounting in Practice? #
This quick guide introduces and guides the process of accounting on a cash basis during the financial year. However, at the end of the financial year, the accounting is converted to accrual basis through closing entries. This is a fairly common and straightforward way for small businesses to do accounting, which is why we focus on it in this quick guide.
Step 1: Retrieve the bank statement or other financial transaction report #
Based on the bank statement or other financial transaction report, such as a cash report, it is easy to do accounting on a cash basis. When making entries from the bank statement, it may be beneficial to do the accounting monthly, as bank statements are usually also generated on a monthly basis.
First, it is advisable to check the opening balance for the period or month from the bank statement, which is usually displayed at the top of the first page of the bank statement. The balance, i.e., the amount of money in the bank account at the beginning of the month, should correspond to what is also shown on the balance sheet report for the respective accounting account (in this case, for example, Account 1910 Bank Account).
Step 2: Recording Transactions #
Once you have confirmed that the bank account balance matches the value in the accounting records, you can start entering transactions. Always begin with the first transaction on the bank statement and process each transaction one at a time. In double-entry accounting, the accounting account for the bank account remains the same throughout the entry of bank statement transactions (e.g., Account 1910 Bank Account).
When money comes into the bank account, first record the amount on the Debit side of the bank account, and then make a corresponding entry on the Credit side to another account (e.g., Sales). Similarly, when money leaves the bank account, first record the amount on the Credit side of the bank account, and then make a corresponding entry on the Debit side to another account (e.g., Purchases). When using NoCFO's Purchase or Sale transactions for data entry, you can simply choose the bank account as the payment method.
Note that if you have multiple bank accounts, each bank account should have its own corresponding account in the accounting records (e.g., 1910 Nordea and 1920 Handelsbanken). The aforementioned transaction recording method applies equally to entering cash report transactions, where the account is typically something like 1900 Cash Assets.
Step 3: Intermediate Checks #
When you are doing accounting based on the bank statement, remember to enter all the transactions listed on the statement. You can, for example, open them as PDFs and mark each transaction once it has been entered into the accounting system.
After you have entered all the transactions from the bank statement, check the end-of-month balance on the bank statement. The balance should be found on the last or second-to-last page of the bank statement, after the list of transactions. The end-of-month balance should match the value in the accounting records for the bank account (e.g., Account 1910 Bank Account) down to the cent.
If the sum in the accounting records differs from the sum in the bank account, there has been an error in entering the transactions. It's advisable to start searching for the error by first checking the matching of the initial balance on the bank statement to the value in the accounting records. After that, you may find intermediate balances on certain days (e.g., around the middle of the month) on the bank statement, and this can be used to try and locate the erroneous transaction. However, if there aren't many transactions on the bank statement, the easiest way is to go through each transaction again and ensure that the transaction amount has been entered correctly in the accounting records.
Step 4: Reports and Reporting #
The most important report for the intermediate checks mentioned above is the Balance Sheet report with detailed account information. The Balance Sheet also contains the values of the bank accounts. The Balance Sheet is a snapshot from a specific point in time (e.g., December 31, 2021) and it shows the values that are in the accounts right after entering the transactions for that day. This is why the Balance Sheet is a good tool to try and find errors, for example, in the entry of bank account transactions.
On the other hand, the Income Statement is a summary from a specific period (e.g., December 1 to December 31, 2021) and it displays the values of the Income Statement accounts during that period. Reviewing the Income Statement provides a good starting point for monitoring the development of your business. Additionally, in NoCFO, you can create comparative periods, so you can effectively compare values on the Income Statement (such as Revenue and Operating Profit) between, for example, December and November. This can give you an understanding of the direction your business is heading.
Step 5: Closing Entries #
At the end of the financial year, it's time to convert cash-based entries to accrual basis. This means that instead of the payment date, the basis for recording an expense is the receipt of the product, service, or other deliverable, and for recording revenue, it's the corresponding delivery of the deliverable.
The financial year is typically 12 months long and often coincides with the calendar year, meaning January 1st to December 31st. Changing to accrual basis accounting essentially means that business transactions that occurred, for example, in December 2020 but were paid in January 2021, should be recorded in the 2020 financial year's accounting.
For example, the electricity bill for December 2020 is often due for payment in January or even February 2021. However, the electricity has been used in December 2020, so when using accrual basis accounting, it should be recorded in the previous financial year. In this case, the amount of the electricity bill is recorded from the Electricity and Gas account to Accounts Payable with the date of December 31, 2020.
In a sales transaction, for example, a product is sold and delivered in December 2020, but the sales invoice is due for payment in January 2021. In this case, the outstanding accounts receivable is recorded as Revenue for the year 2020 and in the Balance Sheet as Accounts Receivable.
When the money comes in or goes out of the account on time, an entry is made so that the money is either debited or credited from/to the Bank Account, and then a corresponding entry is made to Accounts Payable/Accounts Receivable, which cancels out the entry made in the previous financial year.
Step 6: Closing the Financial Year and Finalizing #
Before closing the financial year, in addition to the intermediate checks, it is important to verify that all transactions have been entered into the accounting records and that there is a preserved receipt/invoice/document for each transaction. If there are assets in the Balance Sheet that are subject to depreciation entries, they should also be accounted for before closing the financial year.
Once the accounting for the entire financial year has been reviewed and confirmed to be accurate, the financial year can be closed, and a financial statement can be prepared. The financial statement is used to report the company's financial situation to external stakeholders, such as the Tax Authority and the Finnish Trade Register (PRH) in most cases. In the MyTax service, you can directly enter the company's financial year information for calculating income tax and at the same time submit your financial statements to the PRH (if necessary).
Useful links #
The limitations of cash basis accounting: Vero.fi
Single-entry and double-entry accounting Vero.fi