My client, Katie, currently owns and operates a small home remodeling business.
Each month, her client sends to her a $60k check payment as an upfront or prepayment for materials & labor costs. Then Katie proceeds to purchase the necessary materials and labor to continue the project for her client.
As Katie’s bookkeeper, I do see this $60k deposit into her bank account (each month) and I always book this as “Deferred Income” which is a liability account. This liability account always has an ongoing and fluctuating balance as moneys are received and spent accordingly.
However, one has to know exactly how much moneys to deduct from this liability account in the books and when. This is because this liability account is only reflected on the balance sheet and NOT on the profit and loss; Katie needs to know her profitability each month for this job so she can ascertain whether or not she is spending too much on materials and labor costs. Note: there are other factors that assist in determining this; however for the purposes of this article, I will not delve into these other factors here.
So, in order to move a portion of this “deferred income” amount off of the balance sheet and on to the profit & loss area (hence the name “deferred income”) each month, I simply calculate how much of this $60k payment for the month was spent on project costs. Once I have this total, then I proceed to make a journal entry: Debit to the Deferred Income liability account and a Credit to an Income account (that will be reflected on the Profit & Loss statement). Some important notes here:
- The ongoing expenses will be seen in Katie’s bank account as she spends the money and I book these accordingly that will affect the expenses area of the Profit & Loss statement.
- The expenses, as Katie spends the money, and the income account, as referenced above, will offset each other.
- For Katie, the only profit she is making on this project is her separately billed management fee of $12k each month. This is because there is no direct markup on the materials expenses.
Note: AccuraBooks is a bookkeeping firm only, so please consult with your C.P.A. for clarification about the contents of this article.