How should a self-employed person or small business set up a simple bookkeeping and recordkeeping system?

In what order do the setup decisions have to be made?

Run the setup once, in this order; steps 1 to 9 are settled before the first entry or payment.

Recording each transaction as it occurs starts with the first entry: the IRS's Publication 583, Starting a Business and Keeping Records, says you may forget expenses when you prepare your tax return unless you record them when they occur. Only refinements such as bank rules and extra reporting categories can wait without cost.

How should business money be separated from personal money?

Publication 583 says to open a business checking account early, keep it separate from your personal checking account, deposit all daily receipts in it and use it for business purposes only. A sufficient separation means every receipt goes into a business account, every business expense is paid from a business account or card and nothing personal is, and every movement between owner and business is recorded as one of the routes below for its entity form, each in its own account, never mixed in with sales or other expenses:

Open an entity's accounts in its own name. The Paying yourself page says a corporate officer is generally an employee, unless the officer performs no or only minor services and neither receives nor is entitled to any pay. An owner working as an officer of their own corporation is therefore generally its employee, so step 4's employees row applies from the first pay; how much to pay is its own question.

Without separation, statements can supply neither opening balances nor a completeness check.

What must the place the books live be able to do?

Publication 583 says that, except in a few cases, the law does not require any specific kind of records, and that you can choose any recordkeeping system suited to your business that clearly shows your income and expenses. For a computerized system it sets conditions: you must be able to produce sufficient legible records to support and verify entries made on your return and determine your correct tax liability; those records must reconcile with your books and return and identify the underlying source documents; and you must keep all machine-sensible records and a complete description of the computerized part of the system, showing the functions performed as data flows through it, the controls ensuring accurate and reliable processing, the controls preventing unauthorized addition, alteration or deletion of retained records, and the chart of accounts with detailed account descriptions. The tests below assume double-entry books kept in software; whether to keep them on paper or single entry instead is its own question. Test the place before entering anything, leaving the full check to step 10:

• It can hold an account list you define, opening balances and a document reference on each entry.
• It takes every business bank and card account's transactions.
• It can produce each kind of output listed under what the finished books produce.
• It gives each person their own login with a second sign-in factor, keeps a change history its users cannot edit, and exports everything.

Which basis are the books kept on, and what does that change?

Publication 583 says that under the cash method you report income in the tax year you receive it and usually deduct or capitalize expenses in the tax year you pay them. Under an accrual method, it says, you generally report income in the tax year you earn it, even though payment may come in a later year, and deduct or capitalize expenses in the tax year you incur them, whether or not you pay them that year. It says you choose an accounting method when you file your first income tax return, that you must use the same accounting method to figure your taxable income and to keep your books, and that once a method is set up you generally need IRS approval to change it. If the business has already filed a return, the basis is the method used on it; otherwise choosing it is its own question. Write the basis down, because the system then works differently:

Goods held for sale add an inventory decision to this step.

Which obligations must the books carry from the first day?

Settle these before the account list, since each adds accounts; which records each requires, and when anything is due, are their own questions:

How is the account list built from how the business earns and spends?

Sort a few months of bank and card statements (for a new business, its expected first months) by purpose and give each recurring group an account:

• Money held and owed. Each bank account, card and loan gets one, owner loans included, and accrual books add receivables and payables.
• Equipment and vehicles. Each class gets a cost account and an accumulated depreciation account, which AccountingCoach's accounting equation explanation calls a contra asset account; each item's cost and depreciation are kept on a depreciation worksheet.
• Owner's equity. It holds capital or stock going in and draws or distributions coming out, with one capital account per partner in a partnership, and a corporation adds retained earnings. Owner loans sit with money owed; guaranteed payments and officer wages get expense accounts of their own, officer wages going through step 4's payroll accounts.
• Income and expenses. Each way of earning you want to see, and each kind of recurring spending, gets one, grouped the way the return groups them.
• Obligations. Sales tax payable and payroll liabilities come from step 4.

Keep an account only if it feeds a return line or answers a question you will ask, and drop any whose contents you cannot describe in one line. AccountingCoach's chart of accounts explanation says accounting software frequently includes sample charts, which a company is expected to expand or modify to meet its specific needs. If your place supplies one, keep only the accounts on the list built above, rename them to match, and delete or hide the rest before the first entry.

Where does each document land, and how is it found from its entry?

Publication 583 says business transactions generate supporting documents containing information you need to record in your books, and suggests organizing them, for instance, by year and type of income or expense. Design the document side so nothing depends on remembering to file:

• One landing place. Every document goes to one default folder or inbox on arrival.
• An identifier. Each document is named by date, counterparty and amount, or numbered.
• A two-way link. Each entry carries its document's identifier or attachment, and each recorded document is marked with its entry, so anything unmarked is unprocessed.
• Paperless entries. Bank fees, interest and transfers between the business's own accounts use the statement line as their document.

If documents will be kept only as scans, Publication 583 says the storage system must index, store, preserve, retrieve and reproduce them legibly and give the IRS a complete and accurate record; that paper originals may be destroyed once the system is tested to establish compliant reproduction and procedures ensure continued compliance; and that the IRS may test it, with penalties possible if it does not meet those requirements, unless the originals are kept. Until you know yours meets all of that, keep the paper. Which documents to keep, and for how long, are their own questions.

When should the books start, and what must be in place at that date?

Publication 583 says taxable income is figured on an annual accounting period called a tax year, so the cleanest start is the first day of a tax year:

If business money has run through a personal or mixed account, start the books no earlier than the day step 1's business-only accounts open: record what the owner moves into them as capital, stock or a loan under step 1's routes, establish the other balances below from documents, and treat anything earlier as months to rebuild separately.

AccountingCoach's answer on start-up money records a non-cash asset at its cash equivalent or fair market value, for a corporation unless the stock issued has a more clear value. That is the value in the books; the basis on which such an asset is depreciated for tax is its own question. Publication 583 says asset records should show, among other things, when and how you acquired an asset and its purchase price, so keep the owner's purchase record; which asset records are required is also its own question.

Before closing an old arrangement, export or keep access to its records: they hold every earlier period and, with a mid-year start, this year's earlier months, which that year's return combines with the new books. Publication 583 says you must keep your business records available at all times for inspection by the IRS.

Publication 583 says a balance sheet shows the assets, liabilities, and your equity in the business on a given date, and that income and expense accounts close each tax year while asset, liability and net worth accounts stay open. So the opening position is a start-date balance sheet on your basis, each balance's document filed under step 6's rule:

On the cash basis these books record a card charge when made, which is why a card balance is posted rather than listed; when a charge counts as paid belongs to the basis question.

AccountingCoach's accounting equation explanation treats owners' claims as residual, after liabilities; a corporation splits equity between stock and retained earnings, a partnership among partners' capital accounts. Posted on the cash basis, last year's invoices would be credited to equity and, when collected, would clear receivables without ever reaching income. Skip the opening position and the books look complete but are not: a missing loan or unpaid tax never surfaces.

Who runs the routine, and what must be written down for someone else to run it?

Name one person responsible for the books, even if it is you, and a backup, and write a rule sheet from which someone who did not design the system can run it:

• Account meanings. One line per account says what goes in and what does not.
• Capture rule. It says where documents land, how they are identified and how entries point to them.
• Setup decisions. It records the start date, the basis, the obligations built in and each opening balance's source.
• Access. It says who can view, record, change payee details or approve payments, each under their own login.
• System description. It holds the computerized-system description set out under where the books live.

A bookkeeper or employee gets the sheet and their own login, with payment rights only under the payment rule below.

What payment rule must be in force before the first payment?

Payee details arrive through inboxes and messages a fraudster can also use, so apply this rule to every payment, whatever its amount and whoever makes it, employee pay included:

• Before the first payment to any payee, and before paying to changed details (phone number, email or address included), confirm them by calling a number that did not reach you through the payee's emails or messages: one the payee's organization publishes, one you looked up yourself, or one given to you in person.
• A number from earlier in that correspondence does not count, nor does a call, meeting link or video call arranged through that thread or any later message in it, since whoever controls it can answer or join.
• Someone other than the person who entered the details confirms them, and the person who entered them does not approve payments to them; the business confirms details an outside provider entered. In a one-person business the owner confirms alone, and nobody checks it.
• Until confirmed, pay only to details or a check address confirmed before the change; with no independent route, the change waits until it can be confirmed in person or through a route you found yourself.
• Never pay through a service that lets a payee change its receiving account out of your sight.
• Before any payment run, check each payee's amount against that payee's approved bill or pay record, not only the total.
• Everyone who can change payee details or approve payments has their own login with a second sign-in factor, and someone who did not make a change reviews it in the software's own history, not a log kept by whoever made it.

What must the finished books produce, and how is their completeness proved?

Publication 583 says your books must show your gross income, as well as your deductions and credits, and that you need good records to prepare accurate financial statements. The books must therefore produce an income statement for any period, a balance sheet at any date, each return's figures, sales tax and payroll liability balances, what customers owe and the business owes (from accounts on the accrual basis, the open lists on the cash basis), and the document behind any entry.

An omission cannot be seen from inside the books, only against a record someone else keeps. Step 1's statements show every movement of the business's money, and Publication 583 says to make sure the bank statement, your checkbook and your books agree; on the accrual basis the statements prove cash complete, not what is owed to and by the business. Build in the comparison:

• Every business account and card is in the books from the start date, rarely used ones included.
• Cash takings are deposited whole, with each day's sales recorded, as in the daily summary of cash receipts in Publication 583's sample system.
• Processor, payment-app and marketplace sales are recorded gross, with fees separate, and their statements are kept.
• Invoices are numbered in one unbroken sequence, so a gap shows a missing one.
• Any Form 1099 you receive, such as a Form 1099-MISC or 1099-NEC, which Publication 583 lists among documents showing gross receipts, is compared with the income recorded from that payer.

Then test the setup once, in this order:

1. Record the first full month of real transactions.
2. Produce every output above from the books alone; a failure points to a missing account, record set or capability.
3. Compare each bank and card balance in the books with its month-end statement. Publication 583 says a bank statement may differ from the books by bank charges not yet entered, deposits made after the statement date and checks not cleared by then, that unrecorded items such as service charges are then entered, and that any difference left is an error to find; never post a figure to force agreement.
4. Trace five entries to their documents and five documents to their entries.
5. Have the backup repeat steps 2 to 4 from the rule sheet alone, or repeat them yourself.

The setup is complete when all five pass.