Bookkeeping is the art of tracking money; where it came from and where it went to. That is all there is to it.
A simple transaction involves 2 accounts. The ‘from’ account and the ‘to’ account. This is what the concept of double-entry means. Trained bookkeepers and accountants use the term ‘credit’ and ‘debit’ to do this. A transaction credits one account and debits another. Hence a double-entry (it’s not two identical entries, it’s the two sides that make up a transaction).
By transposing ‘from’ with ‘credit’ and ‘to’ with ‘debit’, business people (not trained in accountancy) can get a simple handle on how accounting works. But enough of the theory, let’s look at a few examples.
This article explains some common transactions the self-employed need to make plus some of the differences and common pitfalls experienced in bookkeeping tasks between a limited company and the self-employed.
Limited Company Employee And Director Pay
In a limited company, all workers including the directors are employees. Their pay and salaries are direct expenses of the company. A company, for example, could account for its payroll with just a few transactions. The accounts affected would be the bank (the ‘from’ account, ie. where the money is coming from to pay the wages) and some expense accounts to track how much is going to the employees and how much is going to the Revenue for tax etc. (these are the ‘to’ accounts).
For the self-employed, it is a different story. Their ‘salaries’ are not expenses. As a self-employed person, when you take money from the business, it is usually only as a result of the business making a profit. These transactions are typically called ‘Drawings’. You are ‘withdrawing’ money from the business, hence the name.
So, for the self-employed, you will need a ‘Drawings’ account. This should be set up in the ‘Equity’ section of your chart of accounts. Whenever you take money out of the business, create a transaction From Bank To Drawings. In a traditional double-entry system you would credit the bank and debit drawings (so remember the rule: from=credit and to=debit if you want to make sense of it).
Using Personal Cash To Buy Things
Another common transaction is where you have bought something using personal money or a personal credit card. As your personal credit card or money won’t be included in the books, the simplest way is to treat it as cash, as follows:
Create a cash account in your ‘Current Assets’ section of your Chart of Accounts. All payments will be From Cash To [some expense account]. When you decide to pay yourself back from the business make another transaction, but in reverse: From Bank To Cash.
A better way, from an auditing perspective would be to set up a ‘Loan’ account in Current Liabilities. This is important if you need to track cash separately. The transactions are exactly the same as described except you will use Loans instead of Cash.
Finally, opening balances. For a limited company, the opening balances will involve the shares bought by the shareholders. A typical transaction for this would be From Shareholders To Bank.
For the self-employed, you would have an account called ‘Capital’ and make a transaction From Capital To Bank.
All the above and more is explained step by step with tasks and answers in the Accounting for Everyone online certified bookkeeping course. Click below to find out more.