Clearing Accounts: Can Be Used To Fix Business Mistakes
Today I was helping a client use a clearing account, so I googled the term 'clearing account' and looked for some resources to provide my client to help understand their purpose. Everything I read in the top few resulting posts on google was completely incorrect! Follow uTDu for accurate and effective business start-up, accounting and tax info today! Back to clearing accounts...
A check was written out to the business, when it should have been written out to the owner on a personal level. The owner cashed the check through the business and then the business wrote the owner a check.
Because of how quickbooks records deposits, the check was recorded as revenue (or business income) when the cash was deposited into the bank account and then as contractor expense when paid back to the owner. This means the 'mistake' was showing up as business revenue and expenses - but it was neither!
#1 Debit: Cash - Business Bank Account (Asset)
Credit: Service Income - Quickbooks Sales Receipt (Revenue)
#2 Debit: Contractor Expense - Joe Shmoe (Expense)
Credit: Cash - Business Bank Account (Asset)
One side of each of the two entries was correct: the cash being recorded into the bank account and then cash going out of the bank account, because this is what actually happened! However, because income and expense did not actually occur, this was the mistake, we need to fix, with a 'clearing' account.
As the name implies, this account is simply being used to 'clear' out this transaction and will be affected by each of the two transactions in place of Revenue and Expense. The result is the clearing account will be zero.
Set up an account in your accounting software called 'Clearing Account.' It doesn't really matter what account type you use, but I generally recommend using 'Other Current Asset' or 'Other Current Liability.' In this case, I would use 'Other Current Asset' because with an accounting software like quick books they will only allow certain account types to be recorded in a sales receipt.
Go back to where the two transactions were recorded in the accounting software and change the revenue and expense account to the clearing account. If for some reason you are unable to change the applicable account, you can make a journal entry for the same day, reversing the revenue and expense to the clearing account. The new journal entries are as follows: