The Two Types of Income

Let us assume, the small business owner gathers all the receipts, credit card slips, bank statements, invoices, cheques, wire transfers and other financial information. The next step is recording the information in such a way that meets the needs of the small business owner. The information is usually entered into a accounting software program. In order to provide accurate information about the financial situation of a company, all transactions have to be recorded.

There are a variety of spreadsheet or accounting software programs. The best choice of software depends on a variety of factors. The factors are: type of business, volume and complexity of transactions, money available for software, and future business plans of the owner. For example, a single owner-operated service business in start-up phase may only need a spreadsheet to record all of the financial information. A small, established business usually uses a packaged

accounting program.

In both cases, it is essential that the revenue and costs are properly recorded and categorized. In the ideal world, all costs would be 100% tax deductible and all

revenue is tax-free. However, the reality of the situation is very different. There are some types of costs that that are not fully deductible such as meals and entertainment expenses. Capital asset purchases are assigned capital cost allowance class based on the type of asset purchased. Each capital cost allowance class is assigned a percentage. The maximum allowable deductible cost is calculated by multiplying the cost of asset by capital cost allowance percentage. The portion of the cost that is not used as a deduction for the current year will be carried forward to the next year.

Gas and vehicle repair expenses are deductible based on the percentage the vehicle is used for business purposes. If the costs are not properly categorized the small business owner may not receive the full benefit of allowable deductions.

With using the above examples, there is usually a difference between accounting income and income for tax purposes. For ease of use, some companies will adapt accounting policies that are actually calculations for tax purposes. For example, a month-end or year-end calculation is depreciation. Depreciation is the expired cost of the asset during its estimated useful life. Instead of calculating depreciation and then calculating capital cost allowance, some companies consider the capital cost allowance to be depreciation for accounting purposes. Meal and entertainment expenses are 50% deductible for tax purposes. Half of these expenses are added to the accounting income calculation. Personal portion of gas and vehicle repairs expenses are added to the accounting income calculation. It is important that business mileage records are kept in case there is an audit.

The above examples are common examples that are encountered by many small business owners. They are based on Canadian income tax rules.

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Iva Pederson