Friday, 27 July 2012

How To Account Vendor Deposits and Prepaid Expenses

Vendor Deposit and Prepaid Expenses are two typical accounts that could be easily slipped and

ignored among hundred of daily accounting tasks. Vendor deposit is company’s check that made out of its box to vendors before receiving merchandizes or services company request.

It is an upfront payment, and deserves serious attention, appropriate record and control. Loosing them from your sight may cause a loss on the company side—making payment for merchandizes or services that never received by the company.
Prepaid has no potential loss but it could become a big project on the year-end closing if you don’t allocate them on timely basis every month. So it is another important account that could be easily neglected. So, there should be a solid system to take care of both accounts. How to treat and accounts them? Read on…


Why Do Vendor Deposit and Prepaid Expenses Exist

It’s not uncommon to face the requirement of an upfront deposit on some services such as rent or utilities. The deposits are usually held for a certain time, and then are either returned to you or applied as a credit to your balance by the vendor. Sometimes, vendors want you to prepay all or part of an expense you’re incurring.
Prepaid expenses are usually tracked under the following circumstances:
  • Some vendors may ask for a prepayment on a large order if you don’t have a purchase history with the vendor.
  • Some expenses (e.g. insurance) may require an annual or semi-annual payment that your accountant wants to expense one month at a time.
The funds you remit for any of these transactions fall into the definition of an ASSET—it’s company’s money even though other company or someone else is holding it.
To track these remittances you have to create an asset account for ‘Deposits Held by Others‘ and/or an asset account for ‘Prepaid Expenses’. Both of these are grouped in the ‘Current Assets’.
The reason I suggest naming the asset account ‘Deposits Held by Others’ is to make sure you don’t confuse it with accounts that track deposits you’re holding for customers, such as prepayments on orders, retainers, or other customer monies you’re holding (which are LIABILITIES). Naming an account “Deposits” or “Deposits Held” may be confusing; deposits to whom, from whom?


Tracking and Accounting Deposits Sent to Vendors

Sending a deposit to a vendor is usually a straightforward transaction; you merely write a check. However, the check isn’t an expense, it’s an asset. Therefore, you post it to the ‘Vendor Deposits’ asset account to create the transaction journal seen on the next journal entry (the payee could be the landlord, a utility company, or any other vendor who requires a deposit).
[Debit]. Deposits Held by Others = $800
[Credit]. Bank Account = $800

Returns of Vendor Deposits

Usually vendors return your deposit after a certain period of time. The common method for returning a deposit is to send you a check, but sometimes the vendor may apply the deposit against the next bill.
If you receive a check, all you have to do is deposit the check into your bank account and post the transaction to the ’Deposits Held by Others’ asset account. This creates a transaction journal that is the reverse of the journal that recorded the check you wrote for the deposit.
  • Your bank account is debited (increased).
  • The asset account is credited (decreased).
If the vendor gives you a credit against the current expense (the amount due to the vendor) instead of sending you a check, you have to turn the asset into an expense. The method you use for this action is a journal entry, as seen below:
  • [Debit]. Rent = $800
  • [Credit]. Deposits Held by Others = $800
If the amount of the deposit that’s applied to the next bill is less than the amount of the bill, you have to write a check for the open balance. The check is posted to the appropriate expense, not to the ‘Deposits Held by Others’ asset account. The total of the returned deposit and the check amount equals the expense that’s posted for the month.


Tracking Prepaid Expenses

If you pay in advance when you purchase goods or services from a vendor, that payment is an asset. Create a ‘Current Asset’ account named ‘Prepaid Expenses’ to track these transactions.
When you create the check for the prepaid expense, post it to the Prepaid Expenses account. This credits (decreases) the amount in the bank account and debits (increases) the amount in the Prepaid Expenses account.
To turn the asset into an expense when the vendor’s bill arrives (which may have a zero balance if your deposit was payment in full), create a journal entry that credits (decreases) the Prepaid Expenses account for the amount of your prepayment and debits (increases) the appropriate Expense account. Now you have an expense on the books.
If there are additional charges on the vendor’s bill (such as shipping costs, or the balance due if your advance payment was not for the entire amount), pay those charges the way you usually pay bills, posting the amount to the appropriate expense account.


Allocating Yearly Payments to Monthly Expenses

If you pay an annual fee for a service that’s provided monthly (such as insurance, security services, technical support contracts, etc.), you (or your boss) may want you to track the expense on a monthly basis.
In this scenario, when you write the single check for the annual fee to the vendor, post it to the ‘Prepaid Expenses’ asset account, not to an expense account. You then post the expense by creating a journal entry each month similar to the one seen on the next journal entry—which is the monthly expense for an annual premium of $1,200. The journal entry reduces the ‘Prepaid Expenses’ asset account and increases the expense account.
[Debit]. Insurance = $100
[Credit]. Prepaid Expenses = $100

No comments:

Recommendations of 55th GST council meeting | 21 December 2024

  Summary of the relevant updates is provided below for ease of your reference:   A)     Proposals relating to GST law, Compliances an...