Recognizing a refund that is paid over time

user034256 · ‎July 26, 2020

A service business that is using cash basis method of accounting is required to refund a part of the revenue that was recognized 2 years ago, because the customer determined that there was an overpayment (using a sophisticated formula). The business has not recorded any liability to account for the upcoming refund. The refund amount is large and will be paid over 5 year period. How would you record this? If this is a one-time debit to revenue and credit to notes payable, then the revenue may not be reflected correctly for tax purposes. Only a part is refunded in year 1. On a side note, I read that cash basis businesses do not record long term liabilities. However, if you get a loan and receive (debit) cash, then you must enter the credit entry somewhere. Thus, I conclude cash basis business do have accounts such as Notes Payable, and the refund transaction above must be somehow recorded.

john-pero · ‎July 27, 2020

You are correct that TRUE 100% cash basis businesses do not carry operating liabilities (such as monthly vendor billing) or even accounts receivable (customer invoicing) but this cash basis refers to revenue and expenses and does not preclude the realization of loan liabilities.

If you do carry A/R and A/P on your books you are using a recognized and accepted hybrid accounting method, embraced and allowed by the IRS (as long as you are consistent year to year)

If this were simple A/P you would enter it as a customer credit memo and by refunding it over time your expense (or contra income) in the cm would be realized over time. Simple as creating a partial refund annually. Despite it not being recorded as an actual loan it will hit your balance sheet just the same.

If you would rather treat it as a loan to the business you would record the loan in full against the change in revenue - which would give you full expense today rather tan accrued over 5 years.

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john-pero · ‎July 27, 2020

You are correct that TRUE 100% cash basis businesses do not carry operating liabilities (such as monthly vendor billing) or even accounts receivable (customer invoicing) but this cash basis refers to revenue and expenses and does not preclude the realization of loan liabilities.

If you do carry A/R and A/P on your books you are using a recognized and accepted hybrid accounting method, embraced and allowed by the IRS (as long as you are consistent year to year)

If this were simple A/P you would enter it as a customer credit memo and by refunding it over time your expense (or contra income) in the cm would be realized over time. Simple as creating a partial refund annually. Despite it not being recorded as an actual loan it will hit your balance sheet just the same.

If you would rather treat it as a loan to the business you would record the loan in full against the change in revenue - which would give you full expense today rather tan accrued over 5 years.

user034256 · ‎July 30, 2020

Thank you, John! This is very helpful

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Recognizing a refund that is paid over time