Companies must keep records that are fairly stated for both management and tax reporting
You may choose any form of record keeping that reflects how amounts shown on your financial statements were arrived at. In the past, business owners prepared bookkeeping records were prepared manually. Now however, most companies both large and small keep their records on electronic accounting software. Other than accruals and deferrals, some of which may be non cash items, the primary source for bookkeeping records should be your checking account.
It doesn’t matter how attractive or neat your financial statements may appear, they are just summaries. To the extent possible you must have source documents to prove the amounts in your financials are reasonable. Typically proof of your revenues may be made with your invoices, cash register receipts, hand written sales receipts and bank deposits. Expenses may be proven by similar documents you receive rather than issue. Therefore you may also use your canceled checks to prove purchases that are expenses. Keep in mind, making a purchase does not necessarily equal an expense of your business. Personal expenses are seldom if ever deductible. Other purchases may be extraordinary items which may be deductible, but must be shown separately from operating expenses.
There are items other than cash receipts and purchases that affect your financial statements and taxes
Accruals may come in the form of receivables and payables and may affect both your financial statements and taxes. The IRS will allow you to use cash basis accounting for tax reporting. Cash basis accounting only recognizes actual cash receipts and disbursements. Accounts receivable and payable are not included on financial statements or tax returns. This method of accounting is not a part of “Generally Accepted Accounting Principles”, and its use is discouraged. The elimination of accruals and deferrals may be used to report financial activity on a cash basis, if you can develop a reconciliation for your tax return.
Another group of financial activities which affect accrual basis accounting but must be eliminated if you use cash basis accounting for tax reporting, are non cash items. Non cash items include depreciation and amortization. These expenses recognize the use of a capitalized asset expected to benefit more than one accounting year. An estimate must be made for how much of that asset benefited the year being reported upon, then recognized in financial statements. Cash would already have been spent for an amount that was previously capitalized. The IRS provides estimated useful lives for assets that you may have previously capitalized.