Things About Being An Artist I Wish They Had Told Me In Art School Part 2 - The Joy Of Accrual Accounting
First I have to start by saying that I am not a tax or legal professional, this blog is written for general information purposes only, based on my own anecdotal experiences and to point you in the direction of where to get more information that you might not have known you needed and what kinds of questions you want to ask when doing your own research. This information is accurate to the best of my knowledge in Alberta, Canada in the year 2022. Different rules will apply in different locations and years, you should always do your own research, and if an expert disagrees with me, listen to them, not me. If anything here raises questions for you, please contact an accountant (CPA or CMA), the Canada Revenue Agency, Service Canada, Workers’ Compensation, an insurance agent or broker, or a lawyer, as is appropriate to your situation to get the most accurate information.
There are two methods of accounting, or keeping track of your income and outgo, that the CRA allows: Cash Accounting and Accrual Accounting. Cash accounting is only permitted for certain types of industires, mainly agriculture, fisheries, and mineral extraction. Art businesses are none of these which means we are required by the CRA to use Accrual accounting when doing our book keeping and calculating our taxes.
Cash Accounting is of course the straightforward option. If you are using Cash accounting, basically the date when the money enters your bank account you call it income, and when it leaves your bank account you call it an expense. Easy-peasy. But like I just said above, we artists don’t get to use Cash Accounting so that’s all I’m going to say about it.
Accrual accounting is basically saying you declare the income on the day you earned it, and deduct the expense on the day you used it. Here is an example. December 1 my massage therapist purchases a bottle of massage oil on her way to work which she opens up to use right away so it is entered as an expense on Dec 1, and then she gives me a massage, at the end of which she collects $100 fee so that is entered as income on Dec 1. This is pretty much never how income and expenses work for an artist.
An artist might spend 3 months or 2 years working on an order for a client. She might create a bunch of pieces on spec with no buyer that she hopes to sell someday. She might send inventory that she made out to a gallery on consignement and it sits in the gallery’s posession for 4 years before it sells and she gets paid for it. It might never get sold and she might never get paid for the item. She might collect a deposit before she starts working on an order. If she ships out a wholesale order she might not get paid for 30 days. Sometimes the client disappears and she might never get paid for an order she has shipped. She might receive grant funds for a project she has already completed, or one she won’t be starting for a number of months.
On the expense side, an artist might stock up on several months’ worth of supplies so she has them in stock and can do her work and fill orders in a timely way instead of ordering and waiting for the supplies to arrive before she can start work on the order. Utilities are often billed 2 or 3 months after the usage date. She might pay for 2 years of membership fees at her professional organization in order to get a bit of a discount.
All this makes for muddy accounting and as artists we need to muddle our way through as best as we can. Your accounting method is important as it informs how you calculate GST and income tax and to which periods the income and expenses apply regardless of when the money actually changed hands.
The first thing to note is fiscal periods. These are periods that align with when different taxes are filed and remitted, and also that align with various reports you might want to track for your own information. For example, you might want to track your monthly sales for your own info, you file your GST quarterly, and pay your income tax annually.
The second thing to note is that ‘when you did the work’ and ‘when you billed for it’ and ‘when you actually got paid for it’ rarely line up to the same date, and ‘when you bought the supply’ and ‘when you used it’ rarely line up either. So artists can simplify their accounting with a few guidelines:
Deposits are not included as income until the date the balance of the order has been billed for. (you also don’t collect GST on deposits but rather calculate the GST on the entire amount and add it to the final invoice) (gift certificates are treated the same way)
Income is declared on the date that you invoiced for it.
consigned sales are declared as income for the month that the item sold. So if you receive a sales report and payment for consigned work on the 15th of the month following the sales, you will declare the income for the month the sale happened. You received payment for September’s sales on October 15, in your books the payment is entered as income for September.
small incidental tools and supplies are claimed as an expense on the date of the receipt or invoice.
large quantities of supplies are claimed as an expense on the date you open it. For example, we buy our clear glass by the pallet. If we receive a pallet in October but don’t open and use it until the following February which is the folowing fiscal year for us, we don’t deduct it as an expense until the following fiscal year even though we paid for it in October. On the other hand, if we have melted at least one bag of glass off that pallet before the end of December, then we can deduct the whole cost of the pallet as an expense that same fiscal year.
Any memberships and subscriptions that you pay for monthly just get deducted as you go. If you pay for them annually, you deduct them as of the date you paid the invoice. If you pay for more than one year at a time, you can only deduct one year’s worth per year and you have to remember that you have an expense to claim the following year(s).
At the end of your fiscal year, for example Dec 31 for most sole proprietors, you wait until you have received all your utility bills in January for usage that happened in December before you start working on your income tax, and those bills are applied to the fiscal year ending Dec 31.
If you use an accountant to prepare your income tax, they will want a copy of your bank statement from the month following the end of your fiscal year because this will inform things like utilities and consignment payments. I also give my accountant a list of deposits collected, outstanding gift certificates and anything weird that I don’t understand.
As long as you’re consistently following the same method it at least keeps you from getting confused. The big problem comes at the end of your fiscal periods where you might owe GST on a sale you invoiced but haven’t been paid for yet or income tax on income you have invoiced but haven’t been paid, or you stocked up on a supply and spent the money but can’t deduct the expense yet in that same period. That’s just how it works and know that it will work out in the wash eventually. It’s the biggest problem for new artists who are just starting out and don’t necessarily have the cash flow to cover the remittances when they are due. There isn’t much to do about it. If this is your situation, I would advise just keeping an eye on your cash flow and if you have a big order on Net 45 terms that is ready to ship out at the end of March, maybe wait until the start of April to ship and invoice so that the funds are in your account by the time the GST is due, or if your client really needs it in their hands on March 31, be up front with them and ask them to pay the invoice right away so you can cover your GST bill.
But what if you have invoiced an order and paid the GST and income tax on time but the client never paid it? That, my friend, is what “deducting a Bad Debt” is for. If you have given up hope of ever collecting on an invoice, you deduct it as a bad debt and essentially this reimburses you the GST and income tax you paid on it. You can NOT deduct a bad debt when a consignment gallery does a midnight move and the bank has locked their doors and seized all your inventory. -Tangent here- but if you have your work consigned and the gallery is showing signs of going under, you want to go there and pick up your work and insist they to pay you for work sold. If the bank locks the door, your only recourse is to file as a creditor, and maybe nag the bank to give you your property back. But that’s another blog topic.
On that happy note, here is a picture of some adorable puppies:
