Cash Basis P&L not reporting correctly

Thanks for taking time to post your concern here in the community, @Jsarg. Allow me to clarify this matter for you.

As far as I can see here on my end, paying bills in advance prior to creating them automatically adjusts to the date when the bill was created. Thus, if you pay a bill in a period after the bill date, then the cash/accrual reporting works as it normally should. That being said, having this option to see exact details you need is indeed a great idea. 

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@Jsarg 

I find it hard to believe that the number one accounting software does not report cash basis transactions in accordance with tax code.

The reason it doesn't show on your cash basis P&L in December is that a bill payment creates a journal entry that debits A/P and credits your bank account, neither of which hit your P&L.  The expense transaction is dated in January (the bill).  Therefore, this is a prepaid expense (asset) at year-end for cash basis taxpayers.  That is the proper way to record it from a financial accounting perspective.  The only thing that allows you to deduct this from a tax perspective is the "12-month rule" which is tax code. QB is not tax software, it is financial accounting software, and it has some shortcomings as all do.

I wrote a check for $100 for a business expense in October of 2024. I entered the check as an expense in QB Online and dated the expense October of 2024. That check did not clear our bank account until March of 2025. I prepared a CASH based Profit and Loss report for 2024 for our CPA for our 2024 taxes. That $100 expense is included in the expenses on the cash based Profit and Loss report even though the check did not clear the bank until March of 2025. Can you please explain this?

@BDipp  To my knowledge, there is no method of accounting that is reliant on when transactions clear the bank.

You may be misunderstanding the cash basis method of accounting.

I will admit I might be completely misunderstanding it. Here is why I thought that way. Because for invoicing, I can invoice a customer for work completed in 2024 and have an invoice date of 2024, but they don’t send payment until 2025.  That invoice would not be included on a cash based profit and loss statement for 2024. It is not included as income until 2025 when it is deposited to the bank account. So I assumed it was the same way with expenses. Am I wrong? 

I may be completely misunderstanding it. Here is why I am thinking that way. For invoicing, if I invoice a customer in 2024 for work completed in 2024, but the customer does not send payment until 2025, and that is when the check is deposited, that income for that invoice will not be included on a cash based Profit and Loss report for 2024. That income for that invoice would be included on a cash based Profit and Loss statement for 2025. Is it not the same with expenses?

@BDipp  No worries; the powers-that-be basically make things more complicated to understand than they really need to be.

You are close to a correct understanding, but there is one important thing to keep in mind.

When it comes to cash basis accounting, a core concept is 'Constructive Receipt'.

A common example of this is somebody handing you a money order as payment for services rendered. If there were an IRS agent standing nearby, they would consider you to have constructive receipt of the payment the moment it is in your hands, despite the fact that you have not deposited the money order into your bank account.

Obviously, there is a bit of wiggle room in this when it comes to the mailing system and, to whatever extent, plausible deniability. The IRS isn't actually going to set up surveillance to make sure you recognize payment as of the exact date you picked up the mail, or it arrived in your mailbox, or whatever. But the principle remains; once you have constructive receipt of payment, in whatever form, you should recognize it as income on that day under cash basis.

This also applies to expenses; as far as you're concerned, you have constructively provided payment as of the day you date the check for and, presumably, put it into the mailbox.

It is done this way, in large part, to curtail the shifting of income to different fiscal years. While the mail system can cause its own delays and discrepancies in the payee's recognition of income versus the payer's recognition of expense, the IRS will definitely not knowingly allow the payee to delay recognizing income simply by not depositing the money they have received.

In addition, imagine the mess it would make if other people had control of the outcome of your bookkeeping simply by neglecting to cash their checks or, heaven forbid, paychecks promptly.

In short, while there can be a lot of gray area when it comes to each side recognizing constructive receipt, especially in the absence of communication between payer and payee, a check dated for October 2024 is going to be recognized as an October 2024 expense on the payer's side.

That totally makes sense! I still don’t understand why there seems to be a discrepancy then between QuickBooks Online not accounting for income until it is actually received in try bank versus when it is invoiced, but for expenses, the expense is accounted for when it’s entered in QuickBooks, not when it clears the bank.

@BDipp  This is speculation on my part, but there are two general ways that payments are handled in QB.

First, when the payment is created and applied to the invoice, the amount of the payment ends up in the Undeposited Funds account to be manually deposited into a bank later.

Second, when the payment is created and applied to the invoice, the amount of the payment goes directly to the bank account in question, avoiding the journey through undeposited funds.

While I do not use QBO, and so may be unaware of some peculiarity of its design, I would wager that your company is set up in some way to automatically deposit any payments into the bank account, effectively causing the recognition of payment and the deposit to be simultaneous as far as your records are concerned.

This would cause the illusion that income is not being recognized until it is deposited, even though it's actually happening as a result of payment being applied to the invoice.

That makes sense!  Thank you for all of your help explaining this. I have been doing accounting in QBO for 6 years and never fully understood how this whole thing worked. Thank you so much for all of your time and helpful explanations. I really appreciate it!!! 

@BDipp  RE: Because for invoicing, I can invoice a customer for work completed in 2024 and have an invoice date of 2024, but they don’t send payment until 2025. That invoice would not be included on a cash based profit and loss statement for 2024. It is not included as income until 2025 when it is deposited to the bank account. So I assumed it was the same way with expenses. Am I wrong?

Note that the income is not recognized when the money is deposited, but when it is received - the date the payment is received. It matters not when you deposit it, if you ever do.

But the real difference between the original A/P case and the A/R case just described is that the A/R invoice is first and the payment comes later, but the A/P case has the payment dated before the bill.

When that happens, the income or expense is recognized on the latter date.

Consider what would otherwise happen:

If you recorded the payment in December, which is a transfer between checking and A/P, and it wasn't applied to any bill (it can't be because the bill didn't exist), then it would not appear on your P&L for 2024.

And then, after you record the bill you got in January and apply the payment to it, if QuickBooks recognized the expenses from the bill in the prior December, then the expenses would also not appear on the 2025 P&L!

When there is a prepayment like this, on either the A/R or A/P cases, QuickBooks treats it like an uncommitted amount, sort of like a deposit for something you might purchase or you might sell. Which is a tax nothingburger. And also, for example, the thing you might buy or might sell in the future may not create income or an expense. Consider that buying inventory is not an expense and sales tax you charge is not income - and also the inventory you sell is only partially income.

@BDipp 

The Google AI screenshot you posted is wrong, very wrong.  I'm shocked that it's that inaccurate.

@BigRedConsulting 

"Consider what would otherwise happen:

If you recorded the payment in December, which is a transfer between checking and A/P, and it wasn't applied to any bill (it can't be because the bill didn't exist), then it would not appear on your P&L for 2024."

That's true for QB Desktop, but that's not true for QB Online which is what we're discussing.  QB Online posts payments made to A/P prior to a bill, on cash basis, as an 'Unapplied Cash Bill Payment Expense' as of the date the payment is made.  IMO, this is one major improvement that QBO has over Desktop.

"When there is a prepayment like this, on either the A/R or A/P cases, QuickBooks treats it like an uncommitted amount, sort of like a deposit for something you might purchase or you might sell. Which is a tax nothingburger."

Again, true of QB Desktop but not QB Online.  

@Rainflurry  RE: That's true for QB Desktop, but that's not true for QB Online which is what we're discussing.

Oh. I didn't see that, as the OP asked about Desktop.

Yes, QuickBooks Online does what I think is exactly the wrong thing, for the same reasons I think QuickBooks Desktop does the right thing.

Counting income and expenses before they're recorded - assuming that prepayments will be for income or expenses - seems wrong to me. And will be wrong in many standard cases, such as when buying and selling inventory and when charging customers sales tax.

Ok, I had to read through these all several times to process everything. I should preface this with my QBO version does not give me an option to enter a Bill.If I understand it correctly: 

- if I write a check out for services rec’d 10/15/24, I enter it in QBO as an expense 10/15/24, QBO will reflect that expense on my 2024 Cash Basis P & L regardless of if the check is cashed in 2025. I don’t ever create a “bill” because I do not have that option in my version, so I just enter the check as an expense, it is accounted for as an expense in 2024, and when the check clears the bank I match the transaction to the expense.  

- When I invoice customers for services provided in October 2024, QBO will not recognize income until I receive payment (and I see the difference between when it is marked rec’d in QB vs when it is deposited to the bank). 

Are both of those accurate?

This leads me to one more scenario I now am probably overthinking. Again, remembering my QBO version does not let me enter “Bills”. 

- We have a fuel card with Kwik Trip. They bill monthly for the calendar month. For example, all fuel purchased in December 1-31 of 2024 will be on a statement dated 1/10/25 and will be automatically drafted from our account 1/20/25. In order to keep our monthly P and L somewhat accurate (Inpull an accrual based P&L to see how the month looks, but for all tax purposes we are cash basis). For this example, I have been creating an expense dated 12/31/2024 for the fuel purchased in 12/24 when I receive the statement on 1/10/25, and then when the payment comes out of our bank account I match the bank transaction to the expense I created. Is that ok? Because based on the check example, where the expense is recorded when it is paid, I now am questioning if the what I have been doing is wrong? 

@BigRedConsulting 

Yeah, I missed it at first too.  I'm not a fan of these threads staying open for years and then users asking a similar question but for a different QB version.  It seems to happen quite a bit.

"Yes, QuickBooks Online does what I think is exactly the wrong thing, for the same reasons I think QuickBooks Desktop does the right thing.

Counting income and expenses before they're recorded - assuming that prepayments will be for income or expenses - seems wrong to me. And will be wrong in many standard cases, such as when buying and selling inventory and when charging customers sales tax."

QB Desktop records prepayments to A/R as a negative A/R amount on the balance sheet.  How is a tax preparer going to be able to see a $20K of prepayments buried in a $200K A/R balance?  That $20K is likely income on cash basis.  QBO pulls that transaction out and posts it to 'Unapplied Cash Payment Income' on the P&L so it is easy to identify and the proper tax treatment can be determined. 

On the expense side, cash basis taxpayers can deduct prepaid expenses under the 12-month rule.  But, in QB Desktop, payments to A/P prior to being applied to a bill post as negative A/P and get buried in the A/P balance.  How is a tax preparer going to be able to see that there's $20K in tax-deductible prepayments buried in a $200K A/P balance?  QBO pulls that out and posts it to Unapplied Cash Bill Payment Expense on the P&L so it is easy to identify and the proper tax treatment can be determined. 

To me, QB Desktop takes a one-size-fits-all approach and assumes nothing posting to A/R prior to an invoice is income and nothing posting to A/P prior to a bill is an expense.  At least QBO pulls these transactions so they can be identified and dealt with.

@Rainflurry  "The Google AI screenshot you posted is wrong, very wrong.  I'm shocked that it's that inaccurate."

Job security for the rest of us, I suppose. Didn't actually look at that attachment before you referenced it; kind of reminds me of the group assignments back in university.

"I'm not a fan of these threads staying open for years and then users asking a similar question but for a different QB version."

Imagine if threads containing Solutions actually hard-closed. Maybe the site would run a bit more smoothly without thousands of repeat threads.

Of course, wishes, fishes, and all that. May as well ask for the staff to stop clogging the Unanswered list with their article reblogs.

@BDipp  "We have a fuel card with Kwik Trip."

I swear this forum hides posts for a while.

If your version of QB has a credit card function, you should be using that to track the Kwik Trip charges.

Things like fuel cards are a bit different in that, rather than expending an asset on an expense (writing a check), you are taking on a liability.

By using the credit card function, you are recognizing the expenses as you charge your fuel to the fuel card. Each charge increases your liability to Kwik Trip.

The payment that is drafted from your account each month is, functionally, no different than a loan payment. It is not something that should be treated as an expense in and of itself.

It’s fine. I don’t expect anyone to just be sitting my a computer waiting to answer my questions about QB.  

I do have our other credit cards linked to our QB account, but the Kwik Trip card is not able to link, at least it wasn’t able to last time I have tried. So if there is not a way to link it, then how should I be entering this? 

@BDipp  I'll have to defer to BigRedConsulting and Rainflurry on this question; as mentioned before, I have barely ever used QBO directly. I also have no experience at all with bank feeds or downloading transactions; I just manually enter everything in Desktop.

I would expect there to be some means in QBO to manually enter the information, if nothing else.

@BDipp 

"I do have our other credit cards linked to our QB account, but the Kwik Trip card is not able to link, at least it wasn’t able to last time I have tried. So if there is not a way to link it, then how should I be entering this?"

Set up a new account in your chart of accounts for the Kwik Trip credit card.  To enter the charges, you'll need to enter them manually either when charging to the card or at the end of the month when you receive your statement.  To enter the charges, go to New > Expense.  Choose your KT cc under the 'Payment account' drop-down and enter the details.      

@BigRedConsulting 

"Counting income and expenses before they're recorded - assuming that prepayments will be for income or expenses - seems wrong to me. And will be wrong in many standard cases, such as when buying and selling inventory and when charging customers sales tax."

I need to clarify/correct my previous post.  It was misleading.  As mentioned, QB Desktop records A/R and A/P payments received/made before an invoice/bill as a reduction in A/R and A/P.  However, it does not remove them from A/R and A/P when you run reports on cash basis like it does for invoices and bills.  Therefore, those prepayments should stand alone in A/R and A/P so they can be identified and dealt with from a tax perspective.  This assumes that the user enters all A/R and A/P with invoices and bills.  Sometimes that's not the case.  So, yes, I can understand why you like the way Desktop handles prepayments.  I just think that Desktop is vulnerable to user entry error and can hide these prepayments in inaccurate A/R and A/P balances.      

I like the way QBO reclassifies these prepayments to Unapplied Cash Income/Expense accounts because the vast majority of those payments are, in fact, income and expenses on cash basis.  Customer prepayments are almost always income on cash basis and buying inventory on cash basis is an expense (although cash basis taxpayers that carry inventory should be on accrual basis but that's another topic for discussion).