A Bookkeeper Who Couldn’t Keep the Books

Having a family member work in your business can be a great way to keep business profits in the family. But hiring them as your bookkeeper can be a nightmare, as you will soon learn from our latest tale of accounting horror.

Oct 21st 2020
CPA
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We’ve all seen this far too often, when a small business owner hires a family member to work in the business and, as an afterthought, asks if they can also keep the books. “Sure,” they say, “just get me a copy of QuickBooks and I’m sure I can pick it up.” The real horror begins when their accountant opens up that copy of QuickBooks to begin the tax return.

The one I remember most vividly was a surgeon I’ll call Dr. Backman. He had developed an innovative and relatively non-invasive method for back surgery, but he’d been burned in the past when he worked for big orthopedic practices. So, he hired a nurse, a part-time junior surgeon and, to manage the front desk, he brought on his wife’s sister who I’ll call Nadine.

Now, Nadine had worked with doctors before and had experience running a small medical practice, but I’m pretty sure she had never kept the books for any of them. While she did a fairly credible job with bank recs, it was the income statements that gave me the heebie jeebies.

The balance sheet had exactly five accounts on it: Cash, Savings, Credit Card, Payroll Taxes Payable and Owner’s Equity. "OK," I thought, it’s a new practice and maybe that’s all they have. Oddly, the Credit Card account had a debit balance, but the income statement was the opposite.

It was a massive, 12-page document with hundreds of accounts. It seemed like every time Nadine paid for something, she just added another income statement account.

So, besides the usual accounts like Payroll Expense and Office Supplies, there were accounts for Office Chairs, Remodel Payment 1, Remodel Payment 2, X-Ray Machine, and X-Ray Machine Lease Payments. She had accounts for Dr. Beckman’s computer, her computer, the fax machine, QuickBooks, notepads, break room coffee, pencils and sutures.

On the plus side, it was easy to identify fixed assets and loan payments because everything had its own account. On the negative side, it was a mess to reclassify all the balance sheet items and to consolidate the income statement items into reasonable categories.

I had to get her to fax me the lease agreements for all of the medical equipment the practice had bought. The Credit Card account only showed the payments made, but not the purchases or interest so I had to get all of those from her and get that account up to date.

The biggest problem for Dr. Backman was that he had no idea if his practice was making money or not (Spoiler Alert: it wasn’t). He was flying absolutely blind. In fact, one particularly alarming issue I spotted was that the payroll tax liability account seemed to be growing.

After we wrapped up the tax return for the first year and gave them a cleaned-up QuickBooks file, we spent some time with him and Nadine. We suggested they hire us to do the monthly bookkeeping and to provide business advisory services.

They declined our offer as they couldn’t do that without cutting Dr. Backman’s salary. On the personal side, the Backman’s were way overextended with a large home and expensive cars bought when he had a sizeable salary from a big medical practice.

We warned Dr. Backman about the dangers of not paying payroll taxes. We also spent some time with Nadine to teach her the basics of accounting. We explained the difference between balance sheet and income statement accounts and showed her how to use the amortization schedules we created for all the medical equipment leases.

We hoped that the next year would be better, and that they would heed our warnings, but the next year was no better. Nadine was still recording lease payments as expenses, the credit card was still a mess and there were pages and pages of new income statement accounts. Most of them had just a few dollars for one isolated purchase. 

More alarming, the payroll tax liability account was now over $100,000. Once again, we performed a massive cleanup of the QuickBooks file and again, we warned them that the IRS tended to be pretty harsh when withheld taxes weren’t paid to the IRS.

The practice still wasn’t making any money and the Dr. had to lay off his junior surgeon. By the summer of Dr. Backman’s third year in business, the IRS caught up to him. He had to pull cash out of his retirement account to pay the IRS enough to get them to release the lien on his house.

In the end, he had no choice but to shut down his practice. Gritting his teeth, Dr. Backman went back to work for a big orthopedics practice. So, what lessons can we glean from this horrific tale?

1. Expertise in one field doesn’t always mean you can run a profitable business. I’m sure that Dr. Backman was a terrific surgeon. He was also a very warm and empathetic person. But those characteristics didn’t translate to good business sense.

2. A business plan can make the difference between success and failure. Dr. Backman’s business and marketing plan was basically, “Build it and they will come.” While that worked in Field of Dreams, a medical practice, especially in a niche specialty like back surgery, needs a bit more of a plan to succeed. Marketing also helps.

3. Payroll taxes have to be paid. We accountants know this. Many of us have seen the disasters that happen when business owners ignore this. We can give our clients plenty of cautionary tales about what can happen with trust fund penalties.

But some business owners need to learn this the hard way. Fortunately, Dr. Backman took our advice and hired a great tax attorney who managed to get the penalties and interest reduced. Still, it was very painful financially for Dr. Backman and his wife.

4. Hire a competent bookkeeper. Nadine had a heart of gold and was great at working with insurance companies to make sure Dr. Backman got paid. But business owners need reliable books to make decisions about their businesses. Dr. Backman might have stayed in business if he’d taken us up on our offer to help him with bookkeeping and business strategy.

The real tragedy in all of this was that Dr. Backman lost his freedom to continue innovating in his less-invasive back surgery methods. As a survivor of two back surgeries, I wish his technique had been an option for me!

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