When starting a business, there are many factors that entrepreneurs need to keep track of and prepare for. They must be accountable to their customers, suppliers, employees, business partners, financial institution and the tax authorities. Therefore, one of their many responsibilities is keeping reliable accounting records. These records must be updated regularly and must be easily accessible in the event of a tax audit.
In order to gain a better understanding of the world of business accounting and prepare yourself to assume your obligations, read on to find out what accounting records are and why they are so important.
The importance of accounting records
In the eyes of the tax authorities, accounting records are generally defined as financial and accounting documents that summarize and substantiate a business’s transactions.
Keeping accounting records: a question of compliance
Keeping accounting records is a requirement for all incorporated companies (as well as trusts, non-profit organizations, universities and many others) in Quebec and Canada. The Canadian tax system is based on self-assessment, which means that the government trusts businesses to declare the profits resulting from their commercial activities.
However, the government does not have blind faith in taxpayers. It requires businesses to keep accounting records that detail all of the financial and accounting transactions made over the course of the year. By checking these records, the financial authorities can determine whether you have collected GST/HST in accordance with the law. These records form the basis of a company’s financial statements, which are used to issue tax returns.
In addition to keeping their records up to date, companies are required to keep all supporting documentation for each transaction recorded for a minimum of 6 years. For example, if you want to be able to prove to auditors that a $10k deposit to your bank account is a loan, not revenue, you will need to keep the written contract from your lender.
The same goes for business expenses. If you want to be able to claim the ink you purchased for your printer as a business expense, make sure you have the bill to prove the purchase.
It’s important to note that a transaction listed on your credit card is not considered adequate supporting documentation for business expenses. In the event of an audit, the auditors will require you to submit invoices as evidence.
Well-organized accounting records can lead to tax savings
Comprehensive, well-organized accounting records can help businesses save money on taxes. The records can serve as a reminder for deductible expenses and input tax credits (ITCs).
Accounting records provide a basis for financial forecasting
Understanding your company's past and current financial situation can help you predict how it will perform in the future. You can use the records of past accounts to take stock of your former situation and make adjustments before embarking on new projects.
Unfortunately, SMEs often neglect financial forecasting due to a lack of preparation.
Accounting records can help optimize business management
In any company, accounting is one of the departments where the most information is centralized. If you access and use that information, you can identify your company’s needs and the problems it faces. You can also look for trends, keep track of your earnings or losses and analyze certain KPIs.
This information can help you make important decisions quickly, increase profits and prolong the life expectancy of your business.
How are accounting records kept?
Accounting records can be kept on paper or in digital format, but most companies use reputable accounting software for its simplicity and the peace of mind it offers. Simply enter each transaction into the software, and the information will be recorded in an accounting database that serves as the official accounting records.
Most of these software products have the ability to produce a range of accounting reports, giving you easy access to important data that is often required during a tax audit. The data can also be used to prepare your financial statements and tax returns.
If you don’t want to use accounting software, you can create accounting records yourself, either on paper or in Excel spreadsheets. However, this technique is not recommended, particularly if you have a large number of transactions and a high business volume.
The components of accounting records
Accounting records are made up of multiple components, each of which has many essential elements. Here are a few of the main ones.
The sales journal
The sales journal lists all of the sales the company makes. It includes information such as the date of the sale, the customer’s name, the amount before taxes, the tax details (if applicable), and the total amount.
The expense journal
The expense journal lists all of the expenses the company incurs. It includes information such as the date of the purchase, the supplier’s name, the category of the expenditure, the amount before taxes, the tax details (if applicable), and the total amount.
The cash receipts journal and the cash disbursement journal
Accounting records also include a cash receipts journal and a cash disbursement journal. Each of these journals notes the date, the amount involved and the account used for the transaction.
The journals will also include the type of receipt (customer sale, loan, advance from a shareholder, purchase return, refund, tax, etc.) or disbursement (supplier payment, loan payment, advance to a shareholder, tax payment, salary, etc.) Finally, the source is recorded in order to link it to a transaction.
The payroll journal
One of the main components of accounting records is the payroll journal. As its name suggests, it lists all of the salaries paid for each period. It includes the employee’s name, the pay period, the gross amount, the net amount, and details about source deductions and the employer’s contributions.
Records of accounts receivable and payable
It is also strongly recommended to keep records of accounts receivable and payable. These give companies instant access to information about money owed and owing at any time.
That way, if a customer never pays you, you can withdraw that sale from your revenue to avoid being taxed on it.
Record keeping: a duty for every company
Every company is required to keep accounting records. Remember that the records themselves are not considered adequate proof in the event of a tax audit—you’ll need to keep the supporting documents for a minimum of 7 years. Note that the ink on bills and invoices can fade over the years, so you may want to consider digitizing your supporting documents and keeping them on the cloud or an external hard drive.
Because of the sheer volume of information that needs to be processed, it’s generally preferable to have an accountant manage your records. If you would like advice or help setting up your accounting records, contact our team today.
We work with a variety of accounting software every day. If you are looking for recommendations, we can help you determine which software will best suit your needs.
Frédéric Roy-Gobeil
CPA, M. TAX
As President of T2inc.ca and an entrepreneur at heart, I have founded many start-ups such as delve Labs and T2inc.ca. A former tax specialist at Ernst & Young, I am also a member of the Ordre des comptables professionnels agréés CPA and have a master's degree in taxation from the Université de Sherbrooke. With a passion for the world of entrepreneurship and the growth mindset, I have authored numerous articles and videos on the industry and the business world, as well as on accounting, taxation, financial statements and financial independence.
