How to Handle Large Budget Deposits

How should businesses handle large budget deposits in their bookkeeping and tax reporting? Our resident Bookkeeping Mensch, Paul Rosenblum, walks us through three different accounting approaches, focusing on whether to report these deposits as revenue or only include management fees. Understanding these choices is crucial for business owners, bookkeepers, and accountants to ensure accurate financial reporting and strategic decision-making. And remember—bad bookkeeping is like a broken pencil… pointless!

Transcript

Episode 53

Here’s a trick question:   If a company collects budget deposits, knowing that every penny is accounted for in an event budget and is going to be spent, what is the bookkeeping procedure and what shows up on taxes?  

That’s what I will be talking about today, using a client’s example of a bookkeeping situation that I started with 20 years ago. I’m this week--  (an overworked) Paul Rosenblum. 

There are 3 kinds of payments that clients make to your business. 

1. Paying for goods or services with or without you providing an invoice to them
2. Giving you money up front before you even start a job or project
3. Giving you a large amount of money accounting for a budget that is signed off on in a contract.  

Let’s talk about these in order, and I’ll expand on #3.  

If you sell a service or a product and either provide an invoice or not, the payment will be recorded as income taxable revenue to your company.  If it ever needs to be partially or fully refunded, it would be booked to ‘Customer Refunds’ which is also a revenue account (it’ll show as a negative income amount).  Some accountants book it to an expense category, but it really isn’t.  A write-off would be an expense, but that’s another episode for accrual accounting procedures. 

If you collect money from a customer before a job starts as a ‘downpayment’ on that job- then technically it should not be booked as revenue. It’s a liability according to accounting principles because the amount might have to be refunded even before the job begins, such as in the construction business or in the legal field which would be called (in that case) retainers.  However, most bookkeepers book the downpayments as “Construction in progress” or ‘Retainers’  which would be a revenue account. So, if a refund needs to be made, you will show income coming in, and income going out -- both on the Profit and Loss report. It’s done that because many business owners don’t understand the balance sheet and liabilities or just forget to look at the balance sheet when they look at their monthly profit and loss.  (But not all of you, since you are listening to this podcast!) 

Now let’s expand on #3 on my list.  If you have a large corporate event that you are managing, for one example, and your company and the client signs off on a $500,000 budget and the client wires you $500,000.00, how do you book that into the accounting system?  And where does it show up on the tax return?  

There are usually two ways of booking this to the accounting system. However, today I’ll talk about a third way. 

1. Book the entire deposit as a liability on the balance sheet, because in the event of a natural disaster, the event would be canceled, and a refund could be appropriate if the event isn’t re-scheduled. 
2. Book the entire deposit as revenue, and then as the budget deposit money was spent, use the cost of goods accounts so at the end of the day, in this case the entire $500,000.00 would be booked as cost of goods, deducting from the revenue and zeroing out itself on the profit and Loss report.  
3. If you want to get fancy, book the budget deposit as a negative cost of goods, so at the beginning of the event, the cost of goods account for that event would show a negative $500,000.00, and when money was spent according to the budget, that negative number would get closer to zero. At the end of the event, the cost of goods for that event would show zero.  

The third option would depend on the software that you are using and the features and functions that it has for job costing with its cost of goods accounts, but that’s for another episode.  

Once you decide how you will book these transactions, the next question and conversation that you must have with your accountant is “How do we show this on the tax return?”  

I have had this conversation several times over the years with business owners and accountants.  Do you show the entire $500,000.00 as revenue and then cost of goods when spent, OR do you just count the management fees for the event as revenue and the actual company expenses and leave out the budget deposits on the tax return since in theory the budget deposits and the cost of goods zero out at the end of the day?  

Business owners like to show the total higher amount of revenue because for business loans, for one example, it looks better than just showing the actual fees and not the budget numbers at all.  If you show a $500,000.00 budget deposit as revenue, even though the cost of goods will lower the profit and loss, one can tell the banks that their revenue is higher and it looks better on the Profit and Loss.

Accountants and tax preparers have differing opinions – some want to show just earned revenue in the profit and loss, others want to show everything. 

If you are in that situation as a business, you must have that conversation with the accountant.  There are advantages and disadvantages to showing the higher amount.  In some states, even if your profit is lower, you might pay a state franchise fee based on revenue earned, not the profit figure. In other states, it might not matter. 

Advantage: As a business owner, you can say truthfully that you have a multi-million-dollar business (if the budget deposits are millions of dollars)

Disadvantage: That pesky franchise tax in some states based on revenue only. 

Then the next question might be Accrual or Cash based accounting? If you are in a cash based accounting system, if an event ends in November, and there are any add-ons that weren’t in the original contract and your company gets paid in the next calendar year, then you can’t ‘close’ that event until the next year.  

If you were in accrual accounting, then you could accrue a payment back a year to be able to start and finish and close an event in the same calendar year. 

And of course, there’s modified cash and modified accrual accounting which allow you some benefits of accrual but still reporting on a cash basis.  

I am with the group that believes that the entire budget deposit, even though 100% of it will be spent, should be on the tax return as revenue and the money as it’s spent should be in cost of goods (and if the software doesn’t let you do that and you have to use expenses, you can always label one expense account (Event costs) as a cost of goods account, and have subaccounts of that.

Do the books have to match the tax return by category? Do COGS in the books have to match up with COGS on the tax return?  Not necessarily, especially if the software is quirky and you don’t get all the bookkeeping features that you need in cost of goods.  But the revenue and the net profit do need to match up for audit purposes.

As I spoke about in the last episode when I talked about ethics, bookkeeping is not just data entry.  It’s thinking about the entire end picture and forming a team with an accountant or tax preparer and the business owner. As a bookkeeper, as you know, if you have been listening to other episodes, I take that role very seriously and personally. 

I recently closed the books for the first time with a pretty new client.  The client wanted me to depreciate items, for example, and I explained that I view that as the tax preparer’s job since they have the tax software and bookkeepers don’t. The client wanted to email the profit and loss and the balance sheet report to the tax preparer for them to do a tax return from. I suggested that they let the tax preparer log in and run the reports that they want and also look at any entries that they need to see, but any adjusting entries, give to me to enter and I will get those done.  And then I explained the difference between a bookkeeper’s job and a tax preparer’s job. I know, I am doing a patented digression here, but I thought this is worth mentioning again. But in this situation with how to book certain transactions, the bookkeeper must get together with the accountant and the business owner to make sure all are on the same page.  

Talking about that, I’m going to go back to work and keep on the same page with 10 different accountants, 100 clients, and everything else that I am juggling these days.  

Please email me with any questions or comments at Bookkeepermensch@gmail or check out the website at bookkeepermensch.com and leave me a message or even voicemail.  Would love to hear from you!  

I’m ‘tired and focused at the same time’ ---  Paul Rosenblum