Reducing Tax: Deductions for Small Business
Generally, small businesses can claim a deduction for anything used in producing income. Australian Accounting Standards refer to these deductions as “Expenses” (AASB). Knowing what these expenses are and learning how to generate and analyse a profit and loss statement is vital to reducing your small business's taxable income.
First, expenses need to be correctly allocated to their associated account. The Expense accounts form a part of the Chart of Accounts (COA). The COA includes accounts for Assets, Liabilities, Expenses, Income and Equity. Most accounting software programs include a generic COA as well as industry specific versions that can be further adjusted to suit the needs of individual businesses.
Some deductible Expenses that would typically be encountered in running a small business have been included below, allocated and displayed in a Profit and Loss Statement.
Example (PDF version):
Cost of Sales vs Expense?
A Cost of Sales account/s are for expenses directly attributable to income.
Expenses are overheads that apply to the running of the business or those that can’t be distributed to specific Income accounts.
Alicia designs and makes children’s dresses and accessories. The materials directly attributable to the dress include material and flower decals. The materials directly attributable to the accessories include buttons, sequins and diamantes. By allocating these cost of sales to their associated income accounts, Alicia can determine her gross profit and analyse these margins as discussed in the next example.
The General and Administration, Operating, Employee, Travel and Other expenses follow, as in the example Profit and Loss Statement above.
Another function of the Cost of Sales Account is to analyse profitability.
Deb is a naturopath who offers Consultation and Testing Services to her clients. Her services include Testing, Herbal Medicine Consulting and Supplement Consulting. The directly attributable costs include:
Testing – sending off data to a private company
Herbal Medicine – cost of medicine
Supplements – cost of supplements
Deb sets up her accounts to include an Income account for each type Testing, Herbal Medicine Consultation and Supplement Consultation and a correlating cost of sales account as above. This helps her analyse which service provides her with the greatest gross profit. She then determines Net Profit Before Tax by allocating expenses to General and Administrative, Operating, Payroll, Travel and Other.
Note: “Header” (General and Administrative, Operating, Payroll, Travel and Other) accounts can be used to help group expense types but are not compulsory.
Note: The Cost of Sales accounts may be irrelevant to your business/industry and are therefore not compulsory.
Some accounts will need to be adjusted for personal use. The first year of business is when you will determine these percentages. Expenses such as motor vehicle, mobile telephone, travel and, if using a home office, utilities and rent (non-PSI earners only). These percentages can then be applied through the year.
Commonly we are asked about food and beverage expenses incurred while conducting business. These are known as entertainment expenses. For the small business, this is likely non-deductible. Balance My Books can help you determine this and more, specific to your industry/business structure. We offer ongoing bookkeeping coaching to small and micro businesses which includes a monthly check up of your Profit and Loss account. The Profit and Loss Statement can be prepared monthly, yearly, year to date, month to month comparison. Not only can you analyse your business’s profitability but also learn how to capture the figures to prepare your business’s budgets. As a small business owner, learning to read this Statement should be your goal!
Even after 8 years bookkeeping, we still get some peculiar, industry specific expense queries that make us think!
What expenses are specific to your small business's industry? Are there any you’re unsure of?