Sole Proprietorship: Bookkeeping

A sole proprietorship is not a legal entity separate from its owner, but it is treated as a separate accounting entity. Under the business entity concept, the transactions of the business must be recorded separately from the personal transactions of the proprietor, even though the proprietor reports the net income of the business on the personal income tax return. Sole proprietorship bookkeeping follows the general double-entry procedures described under Bookkeeping Fundamentals, with a simplified equity section and specific rules for the separation of personal and business items, mixed-use property, and preparation of Form T2125.

EQUITY ACCOUNTS

• Owner's Capital: credited with the proprietor's contributions of cash and property and with net income; debited with net losses and the closing balance of the drawings account.

• Owner's Drawings: a temporary account debited with cash or other assets withdrawn for personal use and with personal expenses paid from business funds; closed to Owner's Capital at year-end.

• No salary, wages, or dividends are paid to the proprietor. Amounts withdrawn by the proprietor are drawings, not expenses, and are not deductible.

• The proprietor is taxed on net business income for the year, regardless of the amount withdrawn.

STANDARD ENTRY PATTERNS

• Contribution of cash: Dr Cash; Cr Owner's Capital.

• Contribution of personal property to the business: Dr the asset at fair market value; Cr Owner's Capital. For tax purposes, the property is deemed acquired at fair market value where it changes from personal to business use.

• Withdrawal of cash: Dr Owner's Drawings; Cr Cash.

• Personal expense paid with business funds: Dr Owner's Drawings; Cr Cash.

• Business expense paid with personal funds: Dr the expense (and GST/HST Receivable where eligible); Cr Owner's Capital.

• Withdrawal of inventory for personal use: Dr Owner's Drawings; Cr Inventory (or Purchases), at cost; for tax purposes, the fair market value is included in income.

• Closing: revenue and expense accounts are closed to Income Summary; Income Summary to Owner's Capital; Owner's Drawings to Owner's Capital.

SEPARATION OF PERSONAL AND BUSINESS TRANSACTIONS

• A dedicated business bank account and, where practicable, a dedicated business credit card should be maintained.

• Every transaction through the business account is classified as revenue, expense, asset, liability, contribution, or drawing, with a source document retained.

• Personal expenses (personal groceries, personal clothing, personal travel, personal insurance premiums, personal income tax instalments, and CPP contributions of the proprietor) are drawings, not business expenses.

• Income tax and the proprietor's CPP contributions are personal obligations and are not expenses of the business.

MIXED-USE PROPERTY AND EXPENSES

Business use of home

• Deductible only where the work space is the principal place of business, or is used exclusively to earn business income and on a regular and continuous basis for meeting clients, customers, or patients.

• Eligible expenses (heat, electricity, water, insurance, maintenance, mortgage interest, property taxes, and rent) are prorated by the proportion of floor area used for business, and by hours where the space is shared with personal use.

• The deduction cannot create or increase a business loss; the excess is carried forward to the following year.

• Claiming capital cost allowance on the business portion of a principal residence may affect the principal residence exemption and is generally avoided.

Motor vehicle expenses

• A logbook recording the date, destination, purpose, and kilometres of each business trip, and the total kilometres for the year, must be maintained.

• Operating costs (fuel, insurance, licence and registration, maintenance, and repairs), lease payments, interest, and capital cost allowance are prorated by the ratio of business kilometres to total kilometres.

• Passenger vehicles are subject to prescribed limits on capital cost (Class 10.1), monthly lease payments, and monthly interest deductions, set annually by the Department of Finance.

Other mixed-use items

• Telephone and internet: the business-use proportion of plan costs is deductible; a separate business line is fully deductible.

• Meals and entertainment: deductible at 50% where incurred to earn business income.

• Equipment used partly for personal purposes: capital cost allowance is claimed only on the business-use portion.

METHOD OF ACCOUNTING AND FISCAL PERIOD

• Business income must be computed on the accrual basis, except for farming and fishing businesses, which may use the cash method, and certain commission sales agents.

• The fiscal period of a sole proprietorship carried on by an individual must end on December 31, unless an election is made under section 249.1 to use a non-calendar year-end, in which case additional business income must be estimated and included each year.

• Inventory is valued at the lower of cost and fair market value, or all items at fair market value, applied consistently; artists may elect to value inventory at nil.

PREPARATION OF FORM T2125

• Part 1: identification, industry code (NAICS), fiscal period, and accounting method.

• Part 2: internet business activities.

• Part 3: gross business or professional income, adjustments for GST/HST collected (where included in sales), returns, and allowances.

• Part 4: cost of goods sold (opening inventory, purchases, direct wage costs, subcontracts, other costs, and closing inventory).

• Part 5: business expenses by category (advertising, meals and entertainment at 50%, bad debts, insurance, interest and bank charges, business taxes and licences, office expenses, supplies, legal and accounting fees, management fees, rent, repairs and maintenance, salaries and wages paid to employees, travel, telephone and utilities, delivery and freight, motor vehicle expenses, and other).

• Part 6 and Part 7: net income before and after adjustments, including the business-use-of-home expenses and the share of partnership income where applicable.

• Areas A to F: capital cost allowance schedules for depreciable property, equipment additions and dispositions, building additions and dispositions, and land.

• Bookkeeping categories should be mapped to the T2125 expense lines in the chart of accounts.

GST/HST RECORDS

• Registration is required once taxable supplies exceed $30,000 in a single calendar quarter or over four consecutive calendar quarters; voluntary registration is permitted below the threshold.

• Regular method: GST/HST collected is recorded as a liability and input tax credits as a receivable; the net amount is remitted or refunded with each return.

• Quick method: available where annual worldwide taxable supplies (including GST/HST) do not exceed $400,000; GST/HST is remitted at a prescribed reduced rate on GST/HST-included sales, without claiming input tax credits on most operating expenses.

• Annual filers with a December 31 year-end file the GST/HST return by June 15, with payment due April 30.

PROVINCIAL AND TERRITORIAL CONSIDERATIONS

• Quebec: business income is reported on the federal T2125 and on Form TP-80 (Business or Professional Income and Expenses) with the TP-1 return. GST and QST are recorded in separate accounts and both returns are filed with Revenu Québec.

• British Columbia, Saskatchewan, and Manitoba: separate liability accounts and returns for provincial sales tax, administered provincially.

• Ontario and the Atlantic provinces: single HST account at 13% (Ontario), 14% (Nova Scotia), or 15% (New Brunswick, Prince Edward Island, and Newfoundland and Labrador).

• Alberta and the territories: GST only, at 5%.

• Business name registration, municipal business licences, and provincial permits are recorded as administrative expenses and renewed in accordance with provincial schedules.

SOURCES

• Canada Revenue Agency, Guide T4002 Self-employed Business, Professional, Commission, Farming, and Fishing Income.

• Canada Revenue Agency, Form T2125 Statement of Business or Professional Activities.

• Canada Revenue Agency, Guide RC4022 General Information for GST/HST Registrants; Guide RC4058 Quick Method of Accounting for GST/HST.

• Revenu Québec, Form TP-80-V.