Accounting for business owner taxes, retained earnings.
Keywords: Accounting for income tax, profit.
There are three Income Tax methods that is used in all countries:
income tax = rate * (business revenues - business expenses - allowances), and usually accrued method
income tax = rate * (business revenues - allowances), and usually cash method
income tax = fixed amount (e.g. 500 USD per month.)
The accrued method means that a business revenue or expense occurs when you bought or sold something (a goods or a service) even unpaid. The cash method - when you earn money or paid ones, but it's not a prepayment, i.e. for already sold or purchased a good or a service. According to IRS 583 Starting a business, page 6 Bob as sole proprietor should pay Income Tax, Self-employment tax. He should pay estimated income tax by April 18 (see Form 1040-ES).
Capitalized cost method.
Manufacturing (Producing) business activity is often (in many countries) a subject of the "capitalized cost" method. For the USA see IRS 538, Page 18 Uniform Capitalization Rules. According to this method, the most business expenses are required to be capitalized (i.e. placed into an assets account). For the USA these expenses are - rent, electricity, indirect labor, property deprecation, sales tax from purchases, etc. Part of those costs (or the whole total) are deducting the tax at the end of the period, and that "part" depends on starting and ending inventory (product direct cost). The law provides the equation (formula) to calculate this "part", and in the USA it's called "Simplified Production Absorption Ratio". For example a factory has 0 notebooks at start and it has produced 1000 notebooks. The cost is 100000 (100 each). Assume that warehouse rent expenses are required to be capitalized, and its costs are placed on an asset account e.g. "InventoryCapitalaizedCost.Rent", and at the end of period the Rent expense is 9000. At the end of the period 900 notebooks are sold (90%), so the ending inventory is 10000. Assume that formula of "part to be expense" is (TotalPeriod - InventoryEnd)/TotalPeriod = (100000 - 10000)/100000 = 0.9, so 0.9 of capitalized cost Rent 8100 is deducting the tax, the rest 900 is remained on the assets account.
Bob's earnings.
After Bob has made all business revenues and expenses, his gross income is:
gross income = sum(income revenue accounts) - sum(income expense accounts)
His Self-employment tax is also a gross income expense.
The final closing accounting entries are:
for each gross income revenue account for its final total: Debit [income revenue account] Credit Bob's earnings.
for each gross income expense account for its final total: Debit Bob's earnings Credit [income expense account].
Extract income tax from gross income: Debit Bob's earnings Credit Taxes Payable Federal Income Tax for tax amount.