Escrow is a Bank type account, such as Trust Bank. It is used to hold funds that are not yours.
Pass Through is an asset or liability type of account. It is used for explaining why Funds are moving.
Did you need both? Are you sure this is not a Gross Revenue operation for you, with Gross Expenses that are direct for client names? Just because they related directly to clients, does not mean they are not your income or expense.
Do you have a Trust requirement for these funds?
Thank you so much for your help! There is not a trust. Her accountant used this specific wording:
"We discussed the need to match costs with revenue, so that when revenue is billed, the related estimated costs are accrued at the same time.
So if you think you’re making 20% on a project, and you bill $100,000, and only spend $5,000, you’d accrue the additional $75,000 ($100,000 x .8 less $5k). That way your net profit hits the P&L when you bill.
I’d suggest setting up an accrual account for each project by crediting the accrual (at estimated cost %) and debiting expense (when you bill the client), and then posting all checks to the accrual (cr cash, dr accrual when checks are written).
This way you can see how much you think you have left to pay on all jobs, so they can tell how much extra cash is in the business."
I think there must be a simpler way to track how much extra cash is in the business versus what is reserved for vendor payout than to create an account for EACH event, although there are currently only about 5 events per year, so I could technically do that. As the business grows, though, I think it would be cumbersome. It seems like transferring to a savings account would be much more efficient.
I created the account he mentioned for 2018, but used a liability account. I think this is where I went wrong. This means the collected funds are not reflecting on the PNL and they need to be, even if the funds are being paid on behalf of the client. So, essentially, I'm getting ready to do year end and the books are not showing the full deposit amounts on the PNL, nor are the class PNL's even close to accurate. I'm not sure how to correct this.
You have confused two dissimilar concepts.
Pass-Through means, Never your income and Never your expense.
"The Matching Principal" is a fundamental requirement for businesses, to report accurately to the IRS. This is "you cannot report Expense until you have the related income, and you should not report the income unless you have the related expense timely to the income." That isn't true for all entities. For Cash basis entities, if you have the use of the funds provided, and you don't have a Trust Requirement, and you are not allowed to hold prepaid funds as Liability, then you have Income. Period. It doesn't matter is you started the project, or have no expenses to date. The IRS treats Cash Basis entities as "when you get funds, you just got income and it has to be reported."
The Accrual Basis entity is going to match income to revenue. Example: If I build a Trailer for you that takes 3 months, I would not post my costs as Expense unless the Sale and the revenue is "timely" enough to the costs I am incurring. Otherwise, let's use the example of Nov, Dec, Jan, everything I incur is posted as Work In Progress = other current asset. Once I invoice you in Feb, I have the date of Sale = the Income. That means Feb is when I clear WIP to Expense, as Cost of Goods Sold. And now we have met the requirement of the Matching Principle: Feb has the revenue and the expense, and the Profit.
Or, if I have a three month build cycle, I would also Charge you each month, a partial payment. Now I can post payroll and related costs to expense as usual.
It has Nothing to do with this: "I think there must be a simpler way to track how much extra cash is in the business versus what is reserved for vendor payout than to create an account for EACH event,"
It's not Cash. It's Activities. You are never literally setting aside a dollar you are given, to spend only that specific dollar.
"if you think you’re making 20% on a project, and you bill $100,000, and only spend $5,000, you’d accrue the additional $75,000 ($100,000 x .8 less $5k)."
In QB-ese, this Accrual Basis entity would Invoice for the charge item that is Deferred Revenue (linked to Other Current Liability, not as Revenue). This might be 1/4 Done and 3/4 to do, so you charge 1/4 Income and the 3/4 amount is Deferred revenue.
"That way your net profit hits the P&L when you bill."
Later, then, you bill for the remaining 3/4; you use the Deferred Revenue item on a credit memo and apply that amount to the total invoice owed. This shows the Total Due is reduce by amounts prepaid, and it clears the Prepaid account.
"I’d suggest setting up an accrual account for each project by crediting the accrual (at estimated cost %) and debiting expense (when you bill the client),"
This tells us the CPA has no idea how to use QB. You have Names. You don't need Accounts per project. You only need one Liability account for deferred revenue, because the data flows in and out by your use of the Names on the Transactions. You only need one WIP account, because the data flows in and out of there by the reference of the Customer/Job/Project in the spending details. You don't need more Accounts. You use Names on Transactions and run reports to see that info.
"and then posting all checks to the accrual (cr cash, dr accrual when checks are written)."
Any time someone tells you to use Debits-Credits, that also indicates they don't know QB and they are going to make one heck of a mess in this file. You enter the Check Expense, and you list the Details, which typically for WIP accounting is Noninventory Products and Service Items that are linked to WIP. Example:
I just paid the landscaper for your project and 2 others, so that check expense has three lines, allocating amounts to each Customer name using the WIP Service item for subcontractor Labor which I named for Landscaping. No debit-credit anything.
"It seems like transferring to a savings account would be much more efficient."
Deferred Revenue and Liability have nothing to do with handling the Banking. Sorry. They have to do with "why are funds moving around." Banking = here is a source/destination of Funds, not the Why part of them. You can even be Out of Money, and still have Deferred Revenue and WIP expense accrued.
"I created the account he mentioned for 2018, but used a liability account. I think this is where I went wrong. This means the collected funds are not reflecting on the PNL and they need to be, even if the funds are being paid on behalf of the client."
No, that isn't the case. Let's take this example:
As I build a Single-family residence, the spending transactions are posted to WIP = other current asset. Think of this as building my own Single Inventory Item. Let's spend 7 months building it. I keep accruing Costs into WIP.
And here is why Banking is not linked like you are thinking of it; I could have built it entirely using a construction loan or my own equity funds.
Now, someone Buys it in month 10. That means, in Month 10, I Close WIP to 0, posting the total from WIP into COGS, to match the sales period. That is "The Matching Principle."
And if, in month 9, the customer gives me a Prepayment deposit to hold the house off the market for them, that is my Liability, and that makes it Deferred Revenue until the sale is Closed. That has nothing to do with if the funds exist or not.
A Trust Bank is used to always match Liability on hand to Funds on hand. What you stated is that there is no Trust Bank requirement here.
"So, essentially, I'm getting ready to do year end and the books are not showing the full deposit amounts on the PNL"
Because you told us it is Deferred = Liability. It cannot be in Two Places at once.
"nor are the class PNL's even close to accurate. I'm not sure how to correct this."
Run your Bal Sheet. This is where you should see Deferred Expense (accrued expenses incurred and being held to match to Sales) and Deferred Revenue (charges to customers that are not Income at the time you charged them).
Thank you SO much! I had consulted with several other bookkeepers on this topic and none could quite get through it from start to finish without encountering a reason why their thought process wouldn't work. This information is extremely helpful and provides a tremendous amount of relief for me! I cannot express how appreciative I am for your lengthy and detailed response. Your examples really made a huge difference in clarity for me. I am going to review it about 200 more times :) and then get to work on making corrections. I may have another inquiry about actually creating the WIP, deferred expense accounts, and deferred revenue accounts once I'm done with my review but, hopefully, once I get in there, it will all piece together nicely!
Hi, i'm trying something similar. I am setting up a brokerage on QB and currently creating the flow of the business on the COAs. There are similar transactions that are pass through revenue. The brokerage will receive the commission and any fees charged by the agent that must be paid out to the agent or other 3rd parties. They currently run as cash basis; I was trying to keep things the same but seeing as this happens quite often in their revenue flow - should I suggest switching to accrual basis?
Ex: Agents will charge a fee for generating a new lease agreement. The brokerage receives the funds and pays the agent, this fee has no split all funds go to agent.