November 1, 2008
-
Basic Accounting
I know that most of us are not accountants and that frankly most of us would run screaming if we were forced to account for anything because that's really not the "fly-by-the-seat-of-our-pants" - "go-with-our-gut" - "I can't be out of money I still have checks" way of doing things.
But if I hear one more person expressing consternation over Obama's plan to roll back tax cuts on businesses that make more than $250k per year, I'm going to slap them to the ground, tie them up and force them to memorize the process of business tax accounting.
If you'd like to get in on my little action it goes like this:
The top part of the form which consists of the "Income" section has about 5 lines.
GROSS SALES - lets say you sold hamsters last year, a lot of hamsters, like $1,500,000 worth of hamsters. This is not the amount you pay taxes on. This isn't even the starting point because line 2 is:
COST OF GOODS SOLD which you deduct from your gross sales - see you first had to aquire the hamsters which you sold. Lets assume you got a really good deal on the hamsters and you paid $750,000. That leaves $750,000.You might also have had some INTEREST INCOME if you have money in an interest bearing account or you might have had OTHER INCOME which you don't have to explain to anyone, just add it on in there. But most businesses have negligible amounts of either of these. So for convenience lets just stick with the $750,000 and say that's what you made. Is that the amount you pay taxes on? Oh, my no, not even close. From that amount you deduct everything in the EXPENSE section:
Personnel Expense
Officers Compensation (If you own the company, that means you deduct wahtever you paid to yourself)
Employee Benefits
Interest you paid on the mortgage for your place of business
Repairs and Maintenance
Equipment
Depreciation
Insurance
Taxes and Licenses
Hamster Food
Shrinkage (Hamsters who escaped before making it out the door in the paper box clutched close to little Jimmy's heart - Hamsters are clever, they do sometimes escape)
Transportation Costs
Advertising Expense
and a little line called General and Administrative
where you deduct everything else you can think of including the kitchen sink (office supplies, travel and entertainment expenses, accounting fees, charitable donations you made through your business) - for some companies the G & A line equals all the other deductions put together.I've seen companies that started with $10 million in Gross Receipts end with taxable income of less than $50,000.
Companies that are taxed on more than $250,000 a year are either REALLY BIG COMPANIES or they have REALLY BAD ACCOUNTANTS.
Really.
So the next time you're in a conversation with someone who spouts that utter stupidity about raising taxes on poor little struggling small businesses. Take out your frustrations the way I plan to by educating an idiot who richly deserves it.
Comments (91)
That's funny...lolol...especially the "I can't be broke, I still have checks." lolol. Yeah, I'm like 250,000 is a lot of money and I think at that point you deserve to be taxed...that's just me. I may be more generous than some but I'm thinking if I'm being taxed now and I only make about $20,000 a year and I made less than that last year like maybe uhh $8000...and I was taxed I don't see why if you make more than that you should be taxed more than that. If I have to pay taxes according to my income than you should pay according to yours that's what the tax bracket is for...and people try to skirt around that to save money but I guess the more money you get the more money you want to keep and the rich get richer and the poor get poorer. It makes me sad.
GREAT explanation of how this really works.
When we were applying to the hospital for some charitable relief from part of my bill for last December's emergency hospitalization, the "social worker" who processed our form could have used your little accounting course. She kept insisting that their sliding fee scale had to be based on Greyfox's gross income, not the net after deducting the cost of the merchandise he sells. The average person, alas, thinks like a wage-earner, not like a business owner.
BTW, after some appeals to supervisors and hospital administrators, we got the maximum discount.
why not make the whole thing pretty simple with a flat tax ... say 15% ... wouldn't that stop the graft, cheating, loopholing ... everybody pay their fair share?
Whoa...why don't you tell us how you REALLY feel?
Don't hold back. 
Awesome.
Thanks so much for putting this in terms so easy to understand. I particularly liked your definition of shrinkage, as it might relate to the business of selling hamsters.
@quiltnmomi - I very much appreciate your input ... I rec'd your initial comment ... another Xanga friend (well several) were talking about the flat tax last weekend ... i hope they come here and inform themselves ... again ... thanks.
I am not in favor of plutocracy.
Excellent post.
I especially like the part about shrinkage. Very clever analogy. Of couse, I'm always in favor of analagies where accountants are listed as "clever"
Well put--wish you could get inside my head and write for me!
@Isismoon - @menskeet - @Scriveling - @Ikwa - @DawnsEarlyLight - @SuSu - @soNOTcool - @Rchick2006 - @Karens_Potpourri - @littleredtahbo - Thank you for commenting on my "accounting post" this is some great discussion - SuSu, I think you hit the nail on the head saying that the average person thinks like a wage-earner which is how it is that this "debate" played out in the media is more smoke than substance. It's hard not to be confused when we don't deal with these things directly. Trying to use our frame of reference leaves us talking apples and oranges.
Well said. Yea for you. Judi
@menskeet - I edited my earlier answer because I found a typo and decided to tighten up the whole thing.
I know there are strong arguments for a flat tax, but I oppose it for two reasons. First a flat tax is disproportionately burdensome on lower income earners. Second, trying to figure out what a family's net or gross income is can be relatively easy for most people - it's what their paycheck says. But the higher you get the more complicated it becomes because there tend to be multiple streams of income and multiple ways of calculating it.
The idea behind a flat tax is appealing because it seems as though it would make things more fair, but I believe that ultimately it would make things less fair. I make $30,000 a year as a commerical credit analyst. For me to pay $4500 in income tax would put my family uncomfortably close to the poverty line and would force me to choose and prioritize between necessities. For someone who has income of ... $300,000 the $45,000 they would pay under a 15% flat tax doesn't even cut seriously into their average toy* budget. That's why I say it's disproportionately burdensome on lower income people.
As for my second reason, people who make below $70,000 a year would actually pay the flat rate - (up to $10,500 a year in your example) but higher income people/families have more accounting options for determining their income. In many cases of higher income taxpayers, what they earn at at job is only the pale beginning of their actual income which comes more from interest, dividends, capital gains, and their earnings from companies and partnerships. There's no way to close all the accounting loopholes in determining what their income is from each of these sources because there are multiple different legitimate ways of accounting for assets and liabilities. To close one loophole is to invite a clever accountant to find another.
(I count as toys the airplanes, Harley's, and fourth cars I see on the financial statements of the clients I analyze. I'm not saying that they shouldn't have a Harley, but that I shouldn't have to choose between filling my prescriptions or getting Tucker an eye exam so they can have another Harley.
And btw some of the people I analyze I admire greatly based on their monetary choices, it's astounding to me when I see that someone has made $100,000 in charitable contributions, or that they have $900,000 a year in income and choose to live in a "modest" home in the $300,000 range of value. But these people are about 1 out of 10. The vast majority of the people I analyze have fewer charitable dollars in their budget than I have in mine, and they spend their money on ... toys ... while they take advantage of rules that allow them to prevent their incomes from being taxed.)
I have nothing against being wealthy, I'd LOVE to be in a position to have to choose between writing a check to my University to endow a scholarship, or write a check to United Way to help families who are struggling to support themselves, or write a check to a hospital to pay for poor women to have mammograms, or write a check to pipe clean water to a village in Africa...
But as long as we have people in this country who are having to choose between whether they will pay the electric bill or the hospital bill, I think a flat tax is a bad idea.
Thank you for taking the time and effort to educate people like me---you turned all the mumbo jumbo into a sensible explanation!
@MaryVerina - Thank you for your kind comment.
As long as life is still affordable and worth living after taxes, the country will survive.
@notforprophet - I have a fierce core belief that life is worth living no matter what we can afford.
Thank you so much for your prayers!
This post is worth studying. I am going to print it and do just that. Thank you for spelling it out!!!
Wow! That's amazing. Thank you for educating myself and the others who have already commented. Not only did I learn about the business aspect and who the proposed taxes will ACTUALLY affect, but also through comments about the whole flat tax idea. I've often thought that a flat tax would make more sense, but unless it were a very low number it would be difficult for lower income families (like mine) to meet. Hell, I technically don't even pay taxes. My income has always been low enough that I qualify for a full refund PLUS earned income credit. I could opt to claim exempt when I fill out my W-2's (or W-4's I always seem to transpose which are the ones you fill out when you are hired and which are the ones you submit to the IRS at the end of the year). Anyway, I could opt for exempt and have no taxes taken out in the first place, but since things are so snug for us as is, our tax refund is our only form of savings. When it comes in we use it to buy things we've been wanting but never have the money for, and usually there is catching up on behind bills involved as well. This year, our refund will be used for deposits and things for our own place (if it isn't taken by the state of Missouri for an old debt that I have). Anyway, that's all beside the point. Thanks so much for this post! It really helped me to get a bit of a handle on economics! <3 SuZ
@VioletMoonDancer7 - Thank you, I'm glad this was helpful.
If you qualify for an earned income tax credit, instead of having them exempt you from withholding entirely, you could file a W-5 in addition to your W-2. What that does is give you a portion of the EITC on each check - it works out to about 1/3 of your total credit, so if you ordinarily get $2100 you'd be getting $700 through the course of the year and then a $1400 lump sum. That way you get the best of both worlds. A little back on each check, plus the refund check in the spring. I live pretty close to the bone here, so I use that. It puts about $40 in my pocket each paycheck which doesn't seem like much but it pays for 2 of the boys' therapy sessions every month.
They should have copies of the W-5 at your place of employment but if they don't you can fill it in and print it out at http://www.irs.gov/pub/irs-pdf/fw5.pdf
*runs away screaming* but yea, you're totally right. im actually doing this stuff right now in accounting (an unfortunately required class). it's not fun, and you actually made it easier than my professor did.
@SpAnKyLiCiOuS - Oh you have my sympathy. I enjoyed my accounting classes NOT AT ALL when I was in school so I find it really ironic that I do this for a living now. Hang in there though. I like to think of it all as a puzzle and my job as fitting the pieces together in a way so that it makes sense.
Nice post... someone who knows what they are talking about in Xanga got featured! No way.
Just curious.... has Obama said whether he's taxing gross or net income?
lol speaking of accounting
I should get off and finish my accounting homework
Interesting read though
You're right.
@addicted_2_blogs - WOW! I didn't know. Thank you for pointing that out. I think it's been at least 4 years since I made the featured list and I never expected to get there with a post about accounting.
@PhilippiansThree14 - Business Tax is always on the net and the "Taxable Net" is different from "book net". Taxable net is often lower than the actual net income because there are tax deductions which have no bearing on cash flow. They are useful fictions that allow businesses who perform certain encouraged activities to get a break. Does that help?
@quiltnmomi - mostly, yes... although accounting is too close to math for my liking.
hahaha
Whew, this is good.
i am getting close to giving you 1000 credits
well, you'll get the small percent of my 1000 credits....
Thanks again. I knew about the EIC through the year option, but we prefer to use the refund and EIC in a lump sum anyway. Times when I've had higher paying jobs, I've even claimed "0 or 1" so they would take out more through the year. LOL
@ addicted_2_blogs - This isn't the first time she's been featured. That's actually how I found her back in 2003! Soooo glad I did!
<3 SuZ
@VioletMoonDancer7 - I completely understand using it as a forced savings account. And I think that's an excellent plan. I know that all the "financial planners" recoil in horror at the thought of giving the govt an interest free loan, but those are the same people who are now buying those T bills that are paying so low that they are in effect paying the govt to hold their money. But you know what works for you.
(I didn't realize it had been since 2003! Man you've been with me through ALL the ups and downs! thank you!)
Well, I honestly think that's what we get in political discourse when you combine a nation that educates its populace so poorly in mathematics with one that has such a notoriously poor voter turnout... people get easily bamboozled.
For let's not fool ourselves, people - EVERYone in America is entitled to the best accountants/tax attorneys that money can buy. The more money you make, the more of each you can afford, no?
I'm a blonde and even I can understand...Warren Buffet explained it well using his secretary who was paying more taxes percentage wise than he was and he's a billionaire....go figure that one (except that you just explained it very well thank you)
excellent
Well done! I'm gonna put a link to this on my blog! Hope that adds one more person to this list.
@wixer - Thank you
@slinky - sounds like you've been listening pretty closely to more of the depth and not being sidetracked by soundbites. Thanks for coming by and commenting here. 
thank you for the concrete example. i appreciate your helpful insight.
Oh thank you for this explanation - this has been driving me crazy. I've been wondering how all these small business owners actually stay in business if they can't understand the basic tax accounting rules and are all upset about the $250K!?
I am an accounting major.
And I must agree with the "most of us would run screaming if we were forced to account for anything"...
My parents are forcing me to get a degree in Accounting an be a CPA just like them...
And it stresses me out because I have to do well in this even if I don't like what I do and even if I feel forced to do it.
@blayne7 - Thank you for your kind comment.
@angelena99 - I don't think we're hearing from the small business owners, I think we're hearing about the small business owners and it's always easier to mislead people when both sides are talking outside their frame of reference.
@patbus - Hang in there. I understand about being in a place where you feel forced to do something that wouldn't be your first choice. There are SO many options for someone with a basic understanding of accounting though. Feel free to message me if you'd like to talk about this. I'll bet you can make this work for you.
I applaud you for explaining all this to the nonaccountants!
@klearblueskies - Thank you.
Hey, I hope you are with me on this. I am not putting down your awesome pissed off blog. Everyone who has done taxes should know this. Why is everyone so out of the loop of the obvious? That is what blows me away more. The usual everyday stuff becomes fodder of denial of what is really going on. Gad. This is the most emotionally charged election year I have ever experienced. Great blogs, I am really proud that to see your face on xanga's homepage as featured. Have to tell you, these kind of blogs should be what is featured so high five!
great post!
@queenie - Hey Girl, (High Five) - I agree with you, and underlying my recent very political blogs is a deep dismay that we have so large a group of people who seem not to have enough frame of reference to know when they are being served bullshit. Along with that I have the perception that there are large numbers of otherwise bright people (on both sides) who seem incapable (or too lazy) to think critically about what is being spoken by the parties and simply parrot the party line.
And now that I've basically admitted that I fear we live in a nation of really ignorant (not stupid, they just don't know better) people, I'm not sure how many people really do know the difference between individual personal income tax accounting and business tax accounting. And I think this lack of knowledge has enabled politicians to exploit that ignorance and manipulate people's emotions.
@quiltnmomi - thank you for this post as a whole, and for your explanation of the flat tax. Thanks for taking the time out to do this!
Good Post.
oh wow. i never knew the details to that. thanks for informing us! =]
This is a great example! Thank you so much for posting this. At any rate though, I do think people misjudge how much $250000 really is. To be making above that amount has to be putting you in the top 6 percent of wage earners in the country...or something like that. Anyways, thanks so much!
"to credit or to debit?" now that is the question.
thanks for writing this!
hi...have a nice day !!!
have a nice day !!!!
Wow-- a highly paid job awaits you on someone's campaign staff. Well played, sister! Good thing I was tied up.
So why do you think the Obama campaign hasn't spelled this out? b/c we would run away screaming? It does seem like it's pretty darn relevant to their political ends.
Wonderful post! Well done! My hub and I own an "extremely small" business. I think we need a better accountant.
Cheers!
-M
Thanks for this basic lesson! If I might copy it and print it out for my own personal use I would appreciate your permission. I do not know what to say to people about this topic.. I do not understand accounting, but I know that big business and more medium size ones, get away with a lot.
We grow chickens in America, and kill them, freeze them and send them to China to be cut up and sent back here.. That sounds strange to me , it is one of the many ignorant things we do that waste our precious resources..
I have only read this one example on your blog.. Hope to read more,, have a great day. thanks!!
Rosemoss
sigh im in the real world now arent i....
thanks for the explanation!
Thanks for the accounting lesson. I love the "I still have checks in my checkbook" comment. Great stuff.
hahah....i am in accounting!
great post!
Your explanation of how to compute TAXABLE income is adequate, but Obama's rhetoric is about a group that 'make more than $250,000'. Is this group based on TAXABLE income? GROSS income? Modified TAXABLE income? Modified GROSS income? Your computation reflects only the very basics of current tax law. Remember, tax laws change nearly every year. Deductions are added, but most times, the deductions are limited. Obama is using a statistically comfortable number, $250,000, coupled with a vague category description, to include a large number of people he is preaching to. A huge majority of us fall within this very broad and general category.
You are correct in suggesting that people are uniformed about how taxes are computed, but your simple explanation only touches the surface of the computations. If Obama is elected, THEN he will come out with the specifics. Will ordinary middle class people like you and me discover that they are now "Rich", and because of tax rate adjustments for all levels of income, our tax bill will increase? If he is elected, we will find out.
thanks for posting this! as an accounting student, it made me excited to see someone posting something on accounting!
*pushes up nerdy glasses* you are awesome!
haha, I love this post.
Too many people seem to be buying into this OBAMA'S A SOCIALIST AND HE'LL DESTROY JOE THE PLUMBER LOL crap, but they don't actually analyze the situation.
I'm an accounting major and an auditorr for our state government. Great post.
Interesting post. Haven't really thought of this before. =P
I think you're pretty smart.
-NDSR
Thanks for writing this! I appreciate seeing things from your perspective - and I think it must be fascinating to get an inside look at where so much of people's money goes.
That would be, honestly, my only motivation to do a job that involves numbers... 
kudos on using hamsters as an example.
@DuckTapeJourneyman - I'm glad you enjoyed that line. It's a joke between me and my dad that goes back about ... longer than I want to say. And when I took the position I now hold as a Credit Analyst, I had it printed on my checks above the signature line.
@Rosemoss - You are welcome to print this. Thank you for your comment. I hope you will read more and comment on anything you want whether you agree with me or not.
@OnTheHoof - I'm guessing that you're not a tax accountant? You're correct that each of the categories that I named have sub-categories and that there is more to it than I showed (but really, I wanted people to READ this) you are incorrect to state that there is wide variance from year to year or that the deductions are somehow limited.
At the risk of pointing out the obvious, no one is taxed on anything other than taxable income - that's what taxable income means. People - not companies - individuals who make $250,000 a year also get to deduct a whole lot of expenses before they arrive at the amount that they actually pay taxes on, and very very few of those people pay taxes on more than about 40% of their actual cash flow/income.
Now it's possible that Obama may have some nefarious plan to completely turn cash accounting on it's head and rework the tax code, but I rather suspect not. There are far too many entities that contribute to accounting standards and practices for him to change it drastically.
Does that help?
@runaheadofme - I hope you meant it that I have a future as a campaign staff person, because that comment just made my whole night.
Yeah, I really do think the reason they haven't spelled it out is that it would take more than 30 seconds and most people's eyes would glaze over. Or they'd run away screaming.
NIce.
@quiltnmomi - LOL ... I am a Certified Public Accountant, and have seen major tax bills passed since 1981!! You are correct in stating that the basic way that taxable income is computed has not changed. My point is that Obama has chosen the $250,000 WITHOUT defining it. THAT, to me, is the deception! I do agree with you in that this is a very complicated subject; you DID handle it well!
I say, GOOD POST! And how terrific that so many have read your post on what is generally considered a boring topic
@quiltnmomi - consider you night "made" b/c that's exactly what I meant!
@OnTheHoof - 1981? That's the year I graduated high school!
I'm sorry if it seemed I was being simplistic in my answers or talking down. As a CPA you know how little the average man on the street cares about income statements or balance sheets and doesn't know book value from budgeting. I'm hoping to move people a couple inches deeper than the soundbites here.
As for Obama not clarifying what he means by "income" his website refers to IRS SOI as his source, which are all based on AGI.
nice post! coming from a finance undergrad who's taken enough accounting classes to confirm
Please come and read my last post. Cliff Stafford
Haha, very true post. I dont think this can be considered "basic accounting" though, as a large portion of the population aren't even familiar with a regular 1040 for the individual and just have someone else do it. And it's a shame that presidential candidates just say things without really doing the necessary research first. It can mislead people and I would agree that if a business has taxable income of 1/4 million, well, they're doing pretty good, especially if they're a small business.
@quiltnmomi - True what you say about the general public. Sounds like you are an educator in your field. Keep up the good work
Thanks for the reference to Obama's site.
@OnTheHoof - Just a lowly Credit Analyst for now. But for 2 years I was the Program Director of a Non-Profit organization that provides financial literacy education to working poor clients. I wrote the book there.
And came away with a deep understanding of just how little people really know about the basics of how money works, much less the more complicated things like tax accounting. 
I like that you provide the perspective of an accountant to this. I admit that accounting and numbers are very hard for me to understand, but it helps to have the words of an expert on things like this. I think I learned something today. Good post.
That is an amazing entry. I enjoyed that
I am not an accountant and do not (yet) own a small business. I hope the "income" works out this way for me. In the meantime, what about the AMT? Again, I am not an accountant, but it seems to me that the AMT is a method of forcing *some* people to pay a flat tax, while allowing others to shield income with deductions. Wouldn't it be more "fair" to have *either* a flat tax for everybody, *or* a deduction-based tax system for everyone? And also...I think the professional middle class is often forgotten in these discussions. There are people who fit the definition of "high-earner" who owe plenty of money in student loans and have only one income stream: a paycheck. Not everyone with a big number on their income tax return is buying a fourth car or a Harley. Lawyers, doctors, CPAs and others who invested heavily in education (in terms of money, time AND effort) have families and medical expenses and professional expenses just like everyone else, along with their education loans.
Thank you! I was actually reall wondering how that worked. I totally get it now.
I learned something about new today. Thanks
This is why I don't study business/economics or anything money-related...makes my eyes all @_@
haha...
@ordinarybutloud - The tax code is (or can be) a complicated thing to work out. But it's not that hard. In my job, very few of the people I work with and do credit analysis for make less than $150,000 a year and most have income over $250,000. Many of them are subject to the AMT, BUT there are still a great many deductions they can take, and most of them still wind up paying way less tax as a percentage of their income than I'll bet you do.
There are SO many ways to shelter your assets. For example, there's something called a Section 179 deduction which allows under certain circumstances the deduction of 100% of the cost of an asset in the first year it's owned. Many of the people I analyze own a business that purchases a new car every year, they write off the price as a Section 179 expense, and drive it as a "business expense". And that's perfectly legal. But it's not a deduction that you or I can take.
I'm not saying that there aren't places where the code might be unfair to wealthy people but in general, it's way more fair to people who have money than those who don't.
And btw, you could probably own a business today, and probably SHOULD own a business today. Because then you can deduct all kinds of expenses. Any hobby that you could turn into a business? Don't wait until you're ready for the "big one" - start small. And then start something else small. Maybe you start eight or nine small enterprises, one of them will take off and be your primary source of income, and you still have another 7 or 8 that are all generating those lovely deductions ... See?
Don't be afraid. This is a country in which you CAN build wealth. The tax code only helps you more the higher you go.
@quiltnmomi - excellent...that is EXACTLY my plan.
I did pretty well in Tax Law but struggle with my law-abiding tendencies when it comes to real "tax planning," a.k.a., deduction-seeking. I'm sure the tax code is friendly to wealth. It's not that friendly to moderately wealthy, educated professionals, in my opinion. The middle to upper-middle class, wage-earner types, who are not entreprenuers. My Obama income-sheltering plan: ask my husband's small-business boss to give him a 401K match instead of a raise. Then, start a small business which is CERTAIN to be a money loser, or a very modest money-maker, because it's a hobby. Ultimately, hopefully, it will make enough money that we can live on it. In the meantime, it can create tons of deductions for me AND give me a legitimate excuse to stay out of the PTA. But I am scared of the AMT.
well i don't know much about accounting and it definitely helped me understand the tax policies more...i most appreciate the information.
Ugh, I'm taking Basic Accounting while I'm still in high school.
I hate it so much.
Way too hard.
Comments are closed.