Unpaid invoices showing up on P&L

@tjonesatolfchurchnet 

"Using Undeposited Funds to receive payments"

If you have received payments to Undeposited Funds, then you have been paid, and should show on your cash basis P&L.  

@CamelleT 

RE: If you run a P&L Detail report, it will display all invoices, both paid and unpaid.

Only on an accrual basis - normally - which is just like the summary P&L. The two should match exactly.

RE: under Cash-based accounting, unpaid invoices should not appear in your P&L report.

Well that depends.

RE: However, when you use Undeposited Funds (UF) to receive payments, QuickBooks treats these payments as received and recognizes them as income in the P&L report.

1) The user didn't ask about unapplied payments.

2) Only QuickBooks Online does this - and it only started doing so recently. QuickBooks Desktop does not - which I maintain is correct.

RE: Then, regarding the proper way of setting up items, you'll just need to ensure you are using the correct Income account.

The income account chosen for an item has no bearing whatsoever on whether or not the invoice appears on a cash basis P&L.

@tjonesatolfchurchnet 

Unpaid invoices will not normally appear on the cash basis P&L, either the summary or the detailed versions.

However, there are cases where they do appear. The most common case, probably, is when there are negative line items on the invoice, which function like returns of previously sold things.

I'm not sure how you've determined that unpaid invoices are appearing. If by double-clicking numbers on the summary P&L, is there anything different about the unpaid invoices that appear compared to the ones that do not? For example, do they have negative line items?

@BigRedConsulting 

"Unpaid invoices will not normally appear on the cash basis P&L, either the summary or the detailed versions.

However, there are cases where they do appear. The most common case, probably, is when there are negative line items on the invoice, which function like returns of previously sold things."

Only the reduction in COGS from the unpaid invoice shows on cash basis P&L, but not income, right?  

"1) The user didn't ask about unapplied payments."

I don't believe @CamelleT or anyone referred to unapplied payments.  The context of this thread is payments applied to invoices.   

"2) Only QuickBooks Online does this - and it only started doing so recently. QuickBooks Desktop does not - which I maintain is correct."

If a user enters a customer payment using Receive Payments, cash increases and A/R decreases.  Are these customer prepayments not considered income when received on cash basis?   

@Rainflurry 

RE: Only the reduction in COGS from the unpaid invoice shows on cash basis P&L, but not income, right? 

I don't think GOGS normally appear on a cash basis P&L for an unpaid invoice, as the sale is not generally included until paid. In edge cases where it does, I'd expect the rest of the invoice details to also appear so things internally 'balance'.

RE: If a user enters a customer payment using Receive Payments, cash increases and A/R decreases. Are these customer prepayments not considered income when received on cash basis? 

Not in QuickBooks Desktop. A transfer between cash and A/R isn't income. It's just a transfer between two balance sheet accounts. This is true whether the transfer is an increase or a decrease to the cash account, and if the other account is A/R or any other balance sheet account. Until the transfer is applied to something, or another transaction is entered to complete the 'accounting event', we cannot know what it is for. For example, if it pays off a loan, it will never be income. If a portion of it pays the sales tax due for an invoice, that portion will never be income. If the invoice it is eventually applied to itself doesn't use any income accounts, the payment will never be income.

@BigRedConsulting 

"Not in QuickBooks Desktop. A transfer between cash and A/R isn't income. It's just a transfer between two balance sheet accounts."

Understood, but why does Desktop leave prepayments in A/R when it’s not a valid cash basis balance sheet account? Cash basis accounting doesn’t have A/R.

IMO, the reason that Desktop doesn’t remove it from A/R is not because it’s correct from an accounting standpoint (see below as to why). It’s because removing the A/R entry created by a prepayment would also remove the corresponding bank deposit, which it obviously can’t do, or the bank account won’t balance.

"Until the transfer is applied to something, or another transaction is entered to complete the 'accounting event', we cannot know what it is for."

That’s accrual accounting, not cash basis accounting. The revenue recognition and matching principles don’t apply to cash basis accounting. There’s no GAAP for cash basis accounting, so we don’t match revenues with expenses or recognize revenue when it’s earned to know that we should classify customer prepayments as income. The IRS is clear that customer prepayments for goods and services or other items are income when received:

IRS guidance from Pub. 538:

Advance Payments
Generally, you report an advance payment for goods, services, or other items as income in the year you receive the payment. However, if you use an accrual method of accounting, you can elect to postpone including the advance payment in income until the next year. However, you cannot postpone including any payment beyond that tax year.

@Rainflurry 

RE: Understood, but why does Desktop leave prepayments in A/R when it’s not a valid cash basis balance sheet account? Cash basis accounting doesn’t have A/R.

Yes you're close in that if there is a transfer into or out of an A/R (or A/P) account from another balance sheet account that is not impacted by the difference between cash accrual accounting, then the only way to balance the balance sheet (and P&L) on a cash basis is to include the account and that part of its balance. Or, at least, that is the way that QuickBooks Desktop does it. There might be another way.

There are exceptions to this. QuickBooks treats inventory asset account and sales taxes in special ways to keep open invoices that use those special accounts from appearing, and it backs out their impact on those special accounts to do so.

Still, there are many weird data stunts that you can pull that will cause an A/R or an A/P balance on a cash basis financial report. These mostly have to do with unlinked transactions that imply something is not properly recorded, or you're not finished yet.

What QuickBooks attempts, which is letting you use A/R and A/P and enter data basically in an accrual fashion, but then back it all out for cash basis reporting, is incredibly complicated. Look at a Balance Sheet Detail report on a cash basis and review the A/R details for kick. How it ever arrives at a 0.00 balance (for most cases) is rather like rocket science.

With that in mind, there are just some things that a cash basis user shouldn't record if they don't want to see an A/R balance. A Journal transactions that uses the A/R account is a good example.

RE: The IRS is clear that customer prepayments for goods and services or other items are income when received:

Well, therein lies the catch. QuickBooks Desktop does not actually pretend know the meaning of an unlinked transfer into or out of an A/R account. It doesn't differentiate between a Journal doing this, or a Check, or a Credit Card Charge, or a Payment. It does not presume that the money is a prepayment - for anything - or that it will be applied to a sale of goods and services. Maybe it will simply be refunded someday. No one knows.

One could argue that if a payment is recorded using the undeposited funds account, but it is not deposited, then it does not exist. It's just a placeholder of some sort, a memo of something that may happen. After all, that is rather like how an unpaid invoice is treated on a cash basis: A sale that doesn't exist, even if you've shipped the goods and completed the work, until the customer decides to pay you.

Taking it up a level, QuickBooks Desktop also respects the accounts you use for goods and services. If you say that a sale of Widget1 should be attributed to an asset account instead of the usual income account, then it does that (so does QuickBooks Online) and then there is never any income that results from that sale. That may or may not be right in some specific case. It doesn't care.

Another comment is that IMO QuickBooks financial reporting is not the same as tax reporting. You've pointed out cases where QuickBooks doesn't create the right report(s) for revenue-recognition for taxes. At least with QuickBooks Desktop, I don't think there was ever an attempt to make the financial reporting in QuickBooks exactly match the rules for tax reporting.

For example, based on what you've written, QuickBooks users (both desktop and online) need to carefully treat unapplied Payments and, if appropriate - if they do represent prepayments that will later be income - then they should adjust their income on their taxes. But inasmuch as those payments will be applied to a non-income event, to the sale of an asset, for example, or to sales tax charged to a customer, that is not and will never be income - on either a cash or accrual basis.

@BigRedConsulting 

"But inasmuch as those payments will be applied to a non-income event, to the sale of an asset, for example, or to sales tax charged to a customer, that is not and will never be income - on either a cash or accrual basis."

The point you're missing is that we're only referring to the proper treatment of a customer prepayment from the date it's received until it's applied to an invoice on cash basis.  QBO records the prepayment as income as of the date received.   Then, QBO reallocates the previously-recorded income based on the invoice.  Desktop does the same, but reallocates it from A/R.  A/R has no place on a cash basis balance sheet and Intuit corrected that in Online.  So, if there ends up being sales tax, fine.  QBO reduces the income and allocates it to sales tax as of the invoice date. 

The point I'm making is that from the date the payment is received from the customer until it is applied to the invoice, it is 100% income on cash basis.  That's true from both a cash-based financial accounting and tax perspective.  It's not A/R on either cash or modified cash basis.  You don't need to believe me, research it. 

One more thought:

IMO, users shouldn't be receiving payments using the Receive Payments function in Desktop or Online without an invoice for the deposit/prepayment to apply it to.  A customer needs an invoice showing the deposit/prepayment item and amount to pay from, and the vendor can use the invoice to allocate the deposit/prepayment item to the appropriate income/liability account based on their method of accounting.  That way, ultimately, none of this is an issue.    

RE: IMO, users shouldn't be receiving payments using the Receive Payments function in Desktop or Online without an invoice for the deposit/prepayment to apply it to.

Agreed.  At the least, such transactions shouldn't exist when it's time to create accurate financial statements.