To help establish a good working chart of accounts you need to answer some questions, in conjunction with your accountant, as to how your business will operate and what is important to you. Some of these considerations might be:

1. Will your business have stock to account for? If so, will it be purchased in finished form or will there be production costs?
2. Are fixed assets a significant portion of your business?
3. Will you sell only one product or service or will there be several types of business?
4. Will you have accounts receivable from customers, which you will have to track?
5. Are you going to sell in only one location or will you do business in several places?
6. Are the products you sell subject to value added tax?
7. Do you need to track costs by department?
8. What type of government controls or regulatory reporting are you subject to?

Each one of these questions can have several answers and will probably generate more questions. Each answer will have an impact on how the chart of accounts is structured. It may seem that developing a chart of accounts is not particularly high on your list of things to do as you start a new business; the amount of time and money which a well organised accounting system may save you can be significant as the need to generate information for various purposes increases. An example of a basic chart of accounts follows this section.

Cash or Accrual Accounting (Back to Top)

One of the decisions to be made as you start a business is whether to keep your records on a cash or accrual basis of accounting. The cash basis of accounting has the advantage of simplicity and almost everyone understands it. Under the cash basis of accounting you record sales when you receive the money and account for expenses when you pay the bills. The increase in the money in “the cigar box” at the end of the month is how much you have made.

Unfortunately, as we all know, the business world is not always so easy. Sales are made to customers and you sometimes must extend credit. Your business will incur liabilities which are due even though you may not have received the invoice or have the cash available to pay them.

Most users of financial statements such as bankers and investors are used to accrual-basis statements and expect to see them. Once you become familiar with them, they provide a much better measuring device for your business operations than cash-basis statements.

Whether you use the cash or accrual basis, it is possible to keep books for income tax purposes on a different basis than for financial statements. It may be more advantageous (less tax) for you to do so. DNA can advise you on the advantages and feasibility of doing this in your particular circumstances.

Accounting Records and Record-keeping (Back to Top)

Another question that the owner of a business must answer is “Who will keep the books of the business?” Will you do it yourself, will the receptionist or a secretary double as a part-time bookkeeper, will you have a bookkeeper that comes in periodically, or will the volume of activity be such that a full-time bookkeeper will be required?

Very often the owners of a business decide to keep the books themselves and underestimate the commitment they have made to other phases of the operation and the time required to maintain a good set of financial records and books of account. As a consequence, the record keeping is often low priority and must be caught up later. This approach, though rarely planned, can require a substantial expenditure of time and money. While it is important for the owners of a business to maintain control and stay involved in the financial operations of the enterprise, this can be achieved by maintaining close control over the cheque-signing function and scrutinising certain records. Your company’s accountant can help develop a good programme of record-keeping duties for you, your employees and any outside book-keepers or accountants you may engage.

A Word about Computers (Back to Top)

The computer is probably the single, most valuable, invention for bookkeeping and accounting since the advent of double entry bookkeeping. If your business includes any of the following, then a computer would be a useful tool in your business:

1. Many repetitive or routine tasks.
2. Lots of paperwork, i.e. suppliers’ cheques, sales invoices, purchase orders, mailing labels.
3. Lots of general correspondence.
4. Written reports, contracts, newsletters, catalogues or brochures.

DNA know about both your business and computers and can take much of the confusion out of the selection process by assisting you in the purchase and installation of your computer.

There are a number of very good, easy to use, accounting software systems which are commercially available, but none of them will solve the problems of inaccurate or poor quality financial records. All they will do is generate bad information faster. This is one of the reasons that the computer has also probably caused more headaches for the owners of modern businesses than any other single cause. If you want to use a computer-based accounting package, either in your own business, with a service bureau, or through your accountant, it is imperative that you generate accurate information to be entered into the system.

The real value of the computer becomes apparent once it is running smoothly in your business. Your accountant can then function in the capacity for which he was trained, not as a “number cruncher”, but as your business adviser, consultant and strategist. Both of you can focus not on producing reports for various regulatory agencies but on analysing your business to make it more profitable.

Internal Control (Back to Top)

What is internal control? It is the system of checks and balances within a business enterprise that helps to ensure that the company’s assets are properly safeguarded and that the financial information produced by the company is accurate and reliable. When you are operating as a “one man shop” or at least handling all of the company’s financial transactions, maintaining good internal accounting control is relatively straightforward.

However, when your company grows to the size where you must delegate some of the functions, it becomes more difficult to ensure that all the transactions are being accounted for properly.

No matter the size of your business, you should always be able to answer “YES” to the following questions:

1. When my company provides goods or services to our customers am I sure that the sale is recorded and the debt is recorded in accounts receivable or the cash is collected?
2. When cash is expended by my company am I sure we received goods or services?

The method used to ensure that these two questions can be answered affirmatively will be widely varied. They are essential stepping-stones to maintaining good control in your business. The solution in your particular instance may be as simple as numbering the sales tickets and being sure ALL TICKETS ARE ACCOUNTED FOR or reviewing all invoices and timecards before signing company cheques. These are fundamentals in a well-run business. As the company grows you will need to consider concepts such as segregation of authority as well as employee fidelity bonds or controlled access storerooms.

No matter what the size of your enterprise, you should consider controlling your business and safeguarding hard earned assets as a priority from the outset.

FIXED ASSETS - TANGIBLE
0010 Freehold property cost
0020 Freehold property depreciation
0110 Leasehold property cost
0120 Leasehold property depreciation
0210 Plant and machinery cost
0220 Plant and machinery depreciation
0310 Fixtures/fittings cost
0320 Fixtures/fittings depreciation
0410 Motor vehicles cost
0420 Motor vehicles depreciation

FIXED ASSETS - INTANGIBLE
0700 Investments
0900 Goodwill

CURRENT ASSETS
1000 Stocks and work in progress
1100 Trade debtors *
1103 Debtors and prepayments *
1200 Bank current account *
1230 Petty cash *

CURRENT LIABILITIES
2100 Purchase ledger control *
2109 Creditors and accruals *
2200 VAT control account *
2300 PAYE/NI creditor *

LONG TERM LIABILITIES
2600 Bank loans
2700 Hire purchase creditors
2800 Lease purchase creditors
2900 Other loans

CAPITAL AND RESERVES
3000 Capital account - balance brought forward
3100 Capital introduced
3200 Profit and loss account
3300 Drawings

* denotes control accounts

SALES
4000 Sales/work done
4009 Discounts allowed
4100 Export sales

OTHER INCOME
4200 Royalties received
4210 Commissions received
4220 Insurance claims
4230 Rental income
4240 Bank interest received

COST OF SALES
5000 Purchases
5900 Opening stock and work in progress
5950 Closing stock and work in progress

DIRECT COSTS
6000 Direct labour
6100 Goods outward costs
6200 Goods inward costs
6300 Packaging
6400 Duty paid
6500 Transport insurance
6600 Sales commissions payable
6700 Royalties payable

OVERHEADS
7000 Motor expenses
7100 Telephone
7200 Wages
7250 Wife’s wages
7300 Rent
7400 Rates
7500 Heat and light
7600 Postage, stationery and advertising
7700 Repairs and renewals
7800 Insurance
7900 Bank charges and interest
8000 Hire purchase interest
8050 Mortgage interest
8100 Accountancy fees
8200 Legal charges
8300 Use of home as office
8400 Protective clothing
8500 Cleaning
8600 Sundry expenses
8700 Subsistence
8800 Profit on asset sales
8900 Depreciation
9000 Bad debt write off

There are two different types of registration - compulsory and voluntary:

A. Compulsory
A person who makes taxable supplies becomes liable to be registered if:

1. At the end of any month, the value of his taxable supplies in the period of one year then ending has exceeded the registration limit, which is £61,000 from 01 April 2006.
2. At any time, there are reasonable grounds for believing that the value of his taxable supplies in the next 30 days will exceed the £61,000 limit.
3. If, where a business carried on by a taxable person is transferred as a going concern, the taxable supplies for the twelve months prior to the transfer exceed £61,000.
4. In the most common situation, i.e. (i) above, the person must notify Customs & Excise of the liability within 30 days of the end of the month in which the value of the taxable supplies first exceeded £61,000. If, for example, the value of the taxable supplies first exceeded £61,000 in the twelve months to 31 March, then Customs & Excise must be notified by 30 April and VAT registration would commence on 1 May.

B. Voluntary

In certain circumstances, it is possible to register on a voluntary basis for VAT even though the value of taxable supplies may never exceed £61,000. This is normally only beneficial where the majority of supplies are being made to customers who are themselves VAT registered, e.g. it would not be beneficial for a domestic painter with taxable supplies of £30,000 to be registered, whereas it would be beneficial for a commercial or industrial painter with the same level of supplies.

The other situation in which a voluntary registration might be beneficial is where the supplies are all zero-rated and no VAT is charged on the transaction. All VAT suffered by the trader on expenses can be reclaimed from Customs & Excise.

In summary, the advantages and disadvantages of a voluntary registration are as follows:

Advantages

• enables input VAT suffered to be reclaimed;
• a VAT number can give the impression that a business is larger than it actually is which sometimes can increase the possibility of obtaining work.

Disadvantages

• the requirement to prepare VAT returns on a quarterly basis and to submit them within one month of the quarter end - is the amount of work involved worth it for the amount of input VAT that can be reclaimed?
• Customs & Excise may visit the business about every five years to ensure that VAT is being properly accounted for.

Taxable Persons and Supplies (Back to Top)

a) Taxable Persons

It should always be remembered that it is a person that is registered for VAT and not a business. If a person has two separate different businesses, both with taxable supplies of £40,000, then that person will be required to be registered for VAT and account for VAT at the appropriate rate on the total supplies of £80,000. It is possible to mitigate the effect of VAT by having one of the businesses operated by a limited company or by a partnership with a relative, but professional advice needs to be taken since Customs & Excise have the power to still treat the two businesses as one if strict criteria are not met.

b) Taxable Supplies

Taxable supplies are all supplies made by a business either to a third party or to the trader himself (goods for own use), which are not exempt supplies. Taxable supplies therefore include zero-rated supplies. The major categories of exempt supplies are:

• Land (but not buildings)
• Insurance
• Postal services
• Betting, gaming and lotteries
• Finance
• Education
• Health and welfare

It is important that at the outset of a business, a trader establishes the VAT status of any supplies being made to avoid mistakes, e.g. the services of a physiotherapist are exempt, whilst the services of an acupuncturist are standard rated.

There are three rates of VAT:

- two standard rates -

17.5%
5% - for certain supplies of fuel and power and sanitary goods

- zero-rated.

The four main areas of zero-rated goods are:

1. Food and agriculture (but excluding pet food and most catering);
2. Printed matter, including books and newspaper;
3. Young children’s clothing and footwear;
4. Passenger transport (but excluding hire cars, taxis and parking).

Any VAT charged by the business, whether at 17.5% or 5% is known as output VAT and the total charged or collected in the VAT quarter is payable to Customs & Excise.

Input VAT (Back to Top)

Input VAT is the VAT that you are charged on your business purchases and expenses (the other persons output VAT) and is normally recoverable in full by a trader who only makes standard rated or zero-rated supplies. Businesses that make some exempt supplies (known as partially exempt businesses) have different recovery rules. The total input VAT suffered in the quarter is deducted from the output VAT charged or collected and the difference is either the amount of VAT due to Customs & Excise or the amount repayable by Customs & Excise.

The majority of input VAT is recoverable but there are special rules for:

1. cars;
2. petrol supplied for private usage;
3. business entertaining;
4. goods sold under a VAT second-hand scheme.

To reclaim VAT you have been charged as input VAT, you must hold valid evidence that you have received a taxable supply, which normally means a valid VAT invoice from a registered trader showing his VAT number and the amount of VAT charged.

Special Events (Back to Top)

VAT was originally described as a simple tax but has gradually become more and more complicated over the last twenty years with changes to the operation of VAT every year.

It is not always possible to calculate each quarter’s VAT liability by merely deducting input VAT incurred from 7/47 of the sales income and professional advice needs to be taken in the following situations:

• Importing and Exporting - either within or outside the European Union;
• Partial Exemption, i.e. where a business makes some exempt supplies, all the input VAT
  incurred is not necessarily recoverable;
• Retail Schemes, i.e. where both zero rated and standard rated supplies are made
  which cannot be separately identified at the point of sale;
• Land and Property;
• Cash Accounting;
• Self-supplies;
• Second-hand schemes for motor cars, used boats, antiques, horses and ponies and others.

Penalties (Back to Top)

The impact of penalties has been considerably reduced since the early 1990’s and the possibility of any business suffering a serious misdeclaration penalty for an innocent error on their VAT returns is low.

The two most important penalties still in existence which every business should be aware of are:

1. Late registration penalty for not registering for VAT at the correct time. The penalty is based on a percentage of the VAT due between the date of registration and the date that the person was required to be registered and the percentage increases dependent upon the lateness of the registration. The penalty is in addition to the VAT that is due.
2. Default surcharge for traders that are persistently late in either submitting VAT returns and/or making payment of the liability due. The penalty is based on a percentage of the VAT due and is on a sliding scale.

VAT Checklist (Back to Top)

Registration

1. Should the business be registered?
2. Is basis of registration correct?
3. Are details on registration certificate correct?
4. Do procedures exist for notifying Customs and Excise of relevant changes?
5. Review position at regular intervals.

Preparation of returns

1. Has return been received? If not, then obtain duplicate from VAT Office.
2. Review sources of information.
3. Prepare draft return.
4. Check for accuracy and completeness.
5. Make payment (if outputs exceed inputs)

Input Tax

1. Do any restrictions on input tax exist?
   - If “Yes”, does an agreed method exist?
   - Does this method maximise input tax?
2. Are invoice additions and calculations checked?
   (c) Is input tax claimed at the earliest tax point?
   (d) Are all claims properly supported?
3. Ensure all supporting invoices kept.

Output Tax

1. Are all income heads reflected for VAT accounting?
2. Are all potential sources of notional supplies considered?
3. Are all potential sources of income (asset sales, etc.) covered by VAT accounting system?
4. Is VAT captured at the correct tax point?
5. Is VAT correctly applied where appropriate?

Money Laundering Regulations

HM Customs & Excise have responsibility for administering certain aspects of The Money Laundering regulations 2003 particularly relating to High Value Dealers (HVDs).

HVDs are those traders who may receive 15,000 Euros (approximately £10,000) in a single transaction or a series of linked transactions. The Regulations principally apply if cash or cash equivalent are offered in settlement.

If you believe you may be a HVD you should discuss this with your advisors or visit the HM Customs & Excise Website at www.hmce.gov.uk.

Further if you believe you may be affected by the Regulations as they related to regulated businesses you should discuss this with your advisors as the penalties for not complying are serious.

The Inland Revenue publish various booklets relating to how PAYE is operated and the legislation that you have to comply with. Not only do you collect and remit PAYE to the Collector of Taxes on behalf of the Inland Revenue, you also operate the sick pay scheme and maternity pay scheme for the DSS. You should run the PAYE scheme in accordance with the legislation and should you fail to comply then the Revenue or DSS will look to you for the tax or NIC you failed to deduct. This can be costly if you are unable to recover the tax and NIC from the employee.

Do you have employees? (Back to Top)

Whether an individual is an employee or not in a particular situation is a question of fact depending on the terms on which he works. The question of whether an individual is employed or self-employed is very important for the business “employing” him or her, as that business has to comply with the reporting requirements.

In certain areas the Inland Revenue has placed emphasis on reclassifying individuals claiming to be self employed and has issued leaflet IR56 entitled “Tax: employed or self employed”. This booklet sets out the questions that should be answered to determine the problem. If you have treated someone as self employed and subsequently after a routine visit from the DSS or Inland Revenue it is clear that they were employees, then the tax and NIC which should have been paid will be assessed on you. Therefore it is important to ensure when using the services of self employed people, that they are in fact self-employed.

If doubt exists as to the status of an individual, the situation can be clarified with the Inland Revenue.

The Operation of a PAYE Scheme (Back to Top)

Upon registration the Inland Revenue will send to you guidelines on operating PAYE, National Insurance, Statutory Sick Pay and Statutory Maternity Pay (employer’s pack).

Included will be a number of forms with which to operate the PAYE and NIC system. You should familiarise yourself with and have supplies of these forms, which are as follows:-

• P11 Deduction working sheet
• P46 Notification to the Inland Revenue where no code has been notified to the employer and application for coding
• P46 (Car) Notification of a car provided for the private use of an employee or a director
• P45 Details of employee leaving
• P14/P60 End of year return and employers certificate
• P35 Employer’s annual statement
• P38A Employer’s supplementary return
• P11D Expenses and benefits
• P9D Expenses payments and income from which tax cannot be deducted.

In order to calculate the amount of tax and national insurance due by an employee, the Inland Revenue will supply you with sets of tables. By reference to the “tax free” tables and an employee’s tax code you will be able to calculate the amount of salary that is not subject to tax. The difference between this figure and the gross amount is the employee’s taxable pay. This can then be calculated by reference to another set of tables. The employer’s and employee’s national insurance is calculated by reference to the gross pay with a third set of tables. Special rules exist for the calculation of national insurance for directors.

The tax and national insurance should be paid to the Inland Revenue by the 19th of the month following that in which the salaries were paid.

In most businesses, the directors, and often the employees, have benefits that are not immediately taxed through the PAYE system, the most usual being the provision of a car and possibly fuel. Class 1A national insurance contributions are due on the taxable value of these benefits in kind and are due on the 19 July following the fiscal year in which the benefits are made available. In addition, the Inland Revenue requires on an annual basis, a form P11D (Return of expenses payments and benefits) for all directors irrespective of income and all employees receiving remuneration including the benefit in excess of £8,500. For those employees earning less than £8,500 but who receive expense payments and benefits, a form P9D is required.

A form P46(Car) needs to be completed quarterly on 5 July, 5 October, 5 January and 5 April if any employees have been provided with or have changed their company car. Further details are given on the taxation of company cars in Inland Revenue leaflets IR132 and IR133. The Inland Revenue will still require form P11D to be submitted annually in addition to the P46 (car) forms.

Which Accounting Year Should I Choose?

If you expect profits to rise steadily year by year, in the case of sole traders/partnerships, an accounting date early in the tax year, for instance 30 April, might be best in the short term, because this will defer the payment of tax on your profit. However, it is important to consider what will happen when you retire. Any accounting date other than 31 March will cause a bunching of your tax liabilities because all your profit that has not been assessed prior to your retirement will be assessed for your final year. There are a number of ways to mitigate the effect of this. You could plan to retire on or shortly after the accounting date, and allow “overlap relief” to reduce the burden. You could build up a reserve to meet the liability, or use the higher profit to permit an abnormally large pension contribution.

On the other hand if you expect to make losses in your early years, an accounting date late in the tax year, for instance, 31 March, will ensure that you get tax relief for those losses as quickly as possible. You would then not be faced with the bunching problem on retirement referred to above.

It will also be necessary to bear in mind the seasonality of your business. As part of the profit for your first period of trading could be taxed twice, it would be unfortunate if a poor choice of accounting date were to accelerate the tax on the profit of your first busy period. In these circumstances it might be preferable to run your first accounts to a date just short of your peak period.

As ever, it is important not to overlook commercial considerations. Your bankers might want to see as healthy a profit as you can manage and this desire could conflict with tax planning. A solution would be to chose a tax efficient tax accounting date, and keep the bank happy with quarterly management accounts.

Tax Returns (Back to Top)

Companies

Companies are charged corporation tax at the rate applicable during the financial year (1 April - 31 March). Where a company’s accounts period spans two financial years the profits for the period are apportioned between the years.