Should payments received be coded as liabilities or income?

[bfranklin03]

Our church routinely accepts payments for items such as clothing and study books, and fees for seminars, retreats and trips. In the past, we have coded the costs of the items/trips as expenses and treated the payments as designated income (but NOT tax-deductible). Therefore, it impacts our income and expenses greatly even though budgeted funds don't have to be used since the money is collected for the items. I have done some research, and I believe that we should be using pass-through liability accounts instead since in each case we are passing the money from one person to another person/organization for a service or product. Are the below two scenarios correct:

Scenario 1: The church purchases 20 t-shirts to sell at $10/each, and they don't intend on using this as any type of fundraiser. They initially pay the ABC T-Shirt Company $200 for the shirts, which results in the following entries:
d) ABC T-Shirt Company Liability
c) Bank Account

As people buy the shirts for $10/each, the payments are coded as follows
d) Bank Account
c) ABC T-Shirt Company Liability

Once all 20 shirts are sold, the negative liability balance is brought to $0.

Scenario 2 is the same as above except the church sells the shirts for $15 as a fundraiser for the children's ministry. Once all the shirts are sold, the liability account would have a balance of +$100. An entry would then be made to d)ABC T-Shirt Company Liability and c)Children's Ministry Income to transfer the excess money out of the liability since it's now income for the church. Is this the proper way to handle pass through payments?

[NeilZ]

Well, both scenarios are using money from the general account, however, for scenario 1, that's not a bad way of doing it as the money liability account should equal zero by the time the sale is over. However, you can't get rid of that liability account (just make it inactive) as its been used and you really can't delete it.

As an alternative to that, and the way I would also set it up for scenario two is this suggestion given a few years ago:

Set up income and expense accounts for each of these programs, using sub-account numbers (in place of the -000 last three digits) to keep the income & expense accounts tied.

01-4405-100 Youth Ministry Income
01-5405-100 Youth Ministry Expense

The Sub-Account Report in Fund Accounting allows you to run reports for specific sub-accounts, showing the selected types of account.

In the example, you create the new accounts using subaccounts. The subaccount report will then show you how much of the expense was repaid, while still showing the initial expense which you want to show for accounting and historical purposes (in case someone down the road wants to know what it originally cost). This will show the actual income on the sub-account report.

I would do the same for the first scenario, but create an income and expense for 'special sales'. These would cover the sale of items that the church does not expect to see income. It should always show an income of 0.00 at the end of the sale on the report.

Pass-thru liabilities should be used when you're collecting for a TRUE pass-thru, that is no church funds were used as 'seed money', and everything coming in is going out. A good example is if the Gideons come and give a talk, then ask for a donation to support their ministry. The money is then tracked from contributions into your checking and the liability account. After a few weeks then a check is written for amount in the liability account and sent to the Gideons. The liability account should then be zero.

Hope this helps.

[bfranklin03]

Thanks, Neil. From your reply, I gather that pass thru liabilities should only be used when the money will be collected BEFORE the receiving organization is paid, and the intent is to pass ALL of the money to that organization. Let's say in the t-shirts example that we expected the total cost to be $200, so we received the $200 before we ever placed the order. Once we placed the order, the invoice was higher or lower than expected. Would it still be appropriate to make the entry that moves the remaining surplus/deficit from the liability account to an income/expense account?

I'm thinking about making an income group for "Cost Reimbursements" and then create separate income accounts under that group to track the payments received for clothing, study books, youth trip fees, event payments, etc. when we know that the church will have to expend money for the items/events before receiving payments (as you described, use "seed money"). Corresponding expense accounts would also be created, and subaccounts would then be used to link those income accounts with the respective expense account. Do you agree that's the best plan?

[NeilZ]

Thanks, Neil. From your reply, I gather that pass thru liabilities should only be used when the money will be collected BEFORE the receiving organization is paid, and the intent is to pass ALL of the money to that organization. Let's say in the t-shirts example that we expected the total cost to be $200, so we received the $200 before we ever placed the order. Once we placed the order, the invoice was higher or lower than expected. Would it still be appropriate to make the entry that moves the remaining surplus/deficit from the liability account to an income/expense account?

FWIW ... if you're ordering shirts, you would normally have an idea what the cost will be before you start collecting, thus you shouldn't have to transfer anything from a liability account. However, if there was a deficit, you would write a check crediting your checking account, and debiting the liability for whatever funds are collected there, and also debiting an expense account for any remainder. There would not be any transfer in this case as you're doing all the entries on the Invoice in Accounts Payable.

As far as surplus, you would create a transaction in Funds Accounting crediting the Income account and debiting the liability account.

I'm thinking about making an income group for "Cost Reimbursements" and then create separate income accounts under that group to track the payments received for clothing, study books, youth trip fees, event payments, etc. when we know that the church will have to expend money for the items/events before receiving payments (as you described, use "seed money"). Corresponding expense accounts would also be created, and subaccounts would then be used to link those income accounts with the respective expense account. Do you agree that's the best plan?

If these would be recurring types of actions, I would think this covers your income/expense worries. The amounts in the expenses would not be budgeted, but your finance committee and/or church board would see that there was a full repayment (plus some additional income) of the initial outlay.

[bfranklin03]

My main concern was understanding when to use income/expense accounts versus pass thru liabilities and I think you've cleared that up. My other goal is to setup the accounts so that the reporting is as clear as possible when using the Budget Report (we currently don't use sub-accounts, but I'm thinking that we're missing out on a very convenient reporting feature by not using them). Each year, we have a youth trip where the students pay their own way, but people also give money as scholarships for students in need (the church decides if/which students get the scholarships, so it's still tax-deductible). This trip occurs each year, but since the students cover the cost, we always have a budget of $0 for Youth Trip Expense account, and we also never have a budget on the Youth Trip Income account (the only income account that is budgeted is the General Tithes and Offerings account). Based on your advice, we will use income/expense accounts instead of a liability to track the payments for the trip because we don't know if we will have to pay the camp before all of the money is received. However, should we put an expected budget on the Youth Trip Expense and Income accounts so it doesn't appear over-budget on the Budget Report? I read somewhere that the church expense budget should include every expense the church expects in incur, but I took that to mean only the expenses that are paid from the general budget.

[NeilZ]

My main concern was understanding when to use income/expense accounts versus pass thru liabilities and I think you've cleared that up. My other goal is to setup the accounts so that the reporting is as clear as possible when using the Budget Report (we currently don't use sub-accounts, but I'm thinking that we're missing out on a very convenient reporting feature by not using them). Each year, we have a youth trip where the students pay their own way, but people also give money as scholarships for students in need (the church decides if/which students get the scholarships, so it's still tax-deductible). This trip occurs each year, but since the students cover the cost, we always have a budget of $0 for Youth Trip Expense account, and we also never have a budget on the Youth Trip Income account (the only income account that is budgeted is the General Tithes and Offerings account). Based on your advice, we will use income/expense accounts instead of a liability to track the payments for the trip because we don't know if we will have to pay the camp before all of the money is received. However, should we put an expected budget on the Youth Trip Expense and Income accounts so it doesn't appear over-budget on the Budget Report? I read somewhere that the church expense budget should include every expense the church expects in incur, but I took that to mean only the expenses that are paid from the general budget.

It is always a good idea to budget for any possible expense that may occur. I would setup the income & expense accounts with sub-account numbers and you can track the costs. I'd check the previous years to see what the cost was, and then include that as the expense budget, along with the average income for the trip and include that as a budgeted amount.