undeposited funds

For some businesses, another firm is both a customer and a vendor.  If you’ve invoiced that firm (as a customer) while they have billed your company as a vendor, they may opt to pay the net amount owed for simplicity and to preserve their own cash balance.  In that case, you’ll need to find a way to process the net payment and at the same time close both the customer invoice and the vendor bill.

In QuickBooks, there are 2 methods to accomplish this:

1. Use a clearing Bank account
2. Use General Journal entries

We favor the second method because it’s more consistent with normal workflow and it more fully documents the transactions recorded.  To mirror Intuit’s own discussion of these methods in their knowledge base article on this topic, we’ll follow their example transaction, where your firm has invoiced a customer/vendor for $100, and that customer/vendor has billed your company $75.  We’ve given this customer/vendor a name, Newco Llc.  QuickBooks doesn’t permit identical names in lists.  For that reason and to better distinguish between the customer account and the vendor account, we’ve appended “(customer)” and “(vendor)” to the company’s name.

Method 1 – Use a Clearing Bank Account

This method involves creation of a clearing account (if you don’t already have one set up) and recording the vendor credit through the Make Deposits function.  Screen shots that illustrate what takes place in important steps follow the description of the steps.

1. Create a new Bank type account, which in our example is named Clearing Bank Account
2. Receive the payment from your customer/vendor to pay the customer/vendor’s outstanding invoice in full, which in our example is a payment of $100, and select Undeposited Funds as the Deposit To account if it’s not already set to that by default
3. Click on the Banking->Make Deposits menu selection and select the payment you recorded in Step 2 in the Payments to Deposit window and click Ok
4. In the Make Deposits window, add a new line item and enter the customer/vendor’s vendor account in the Received From field, your Accounts Payable account in the From Account field, and the amount of the vendor bill that the customer/vendor deducted from his payment as a negative number, which in our example is -75
5. Add a second new line item and enter the customer/vendor’s customer account in the Received From field, the bank account to which you’ll deposit the customer/vendor’s net payment, and the amount of the net payment as a negative number, which in our example is -25
6. Set the Deposit To account to the clearing account created in Step 1, which in our example is the Clearing Bank Account and click Save & Close or Save & New to record the net deposit
7. Click the Vendors->Pay Bills menu selection and select the customer/vendor’s bill to be paid
8. Once the bill is selected, click the Set Credits button, choose the vendor credit that you created in Step 4, and click Done to return to the Pay Bills window
9. Set the Account from which to issue the payment to the clearing account, which in our example is the Clearing Bank Account, and click the Pay Selected Bills button
10. QuickBooks will display the Payment Summary window, advising you that the bill was paid by a credit only, so it won’t be associated with a bill payment check; click Done to complete paying the vendor bill

In a typical use of the Make Deposits function where there is 1 entry for the deposit amount from Undeposited Funds as a positive number, QuickBooks credits (reduces) Undeposited Funds and debits (increases) the bank account selected in the Deposit To field.  Positive amounts on the Make Deposits window represent credits; negative amounts represent debits.  Thus, Accounts Payable is debited (reduced) by the amount of the vendor bill that the customer/vendor deducted from his payment, and the regular bank account is debited (increased) by the amount of the net payment received from the customer/vendor.  Intuit incorrectly describes the entry made in Step 5 as a credit; it’s not – it’s a negative amount, so it’s a debit.

After completing Step 6 above, you’ve recorded the net amount of the deposit to your regular bank account.  Note that the Deposit Subtotal made to the clearing account is 0.00, reflecting its purpose to serve purely as a clearing account to close transactions.  QuickBooks will not allow setting the From Account to your Undeposited Funds account when recording the net amount being deposited in Step 5.  If you combine this deposit item with others, you’ll complicate reconciling your regular bank account.  That’s why it’s a good idea to make each customer/vendor transaction processed through the clearing account a separate deposit.  The need to separate deposits is one limitation of the clearing account method.

After selecting the vendor bill in Step 7, you’ll be able to apply the credit that you created in Step 4 by clicking the Set Credits button.

In the Discounts and Credits window, select the credit.

After selecting the credit, there are no other credits available.  The total of the bills to be paid is 0.00.

As described in Step 10, QuickBooks will display the Payment Summary window.  However, because the bill was paid entirely by a credit, it won’t be associated with a bill payment check, even one with a zero amount.  The vendor’s balance will be reduced by the amount of the payment and the bill will be marked Paid, but there won’t be a transaction recording the payment in the vendor’s transaction list in Vendor Center.  The fact that the transaction list in Vendor Center presents an incomplete record of what was recorded is another limitation of the clearing account method.

Because there’s no bill payment check to delete or void, if you want to undo this process, you’ll need to start by deleting the deposit from the clearing account.  That will leave funds in the Undeposited Funds account and return the vendor bill to an unpaid or open status.

Method 2 – Use General Journal Entries

This method involves making 2 General Journal entries and then processing the customer/vendor’s net payment in your normal workflow.  Screen shots that illustrate what takes place in important steps follow the description of the steps.

1. Click on the Company->Make General Journal Entries… menu selection and record a debit (decrease) to Accounts Payable for the amount of the vendor bill that the vendor/customer deducted from his payment, which in our case is $75; in the Name field for the debit, enter the vendor account name
2. On the same General Journal entry, enter a credit for an equal amount to another account, such as the expense account used on the vendor bill, and click the Save & New button
3. Enter a second General Journal entry with a credit for $75 to Accounts Receivable, and in the Name field for the credit, enter the customer account name
4. On the same General Journal entry, enter a debit for $75 to the same account you used in Step 2 and click the Save & Close button
5. Click on the Customers->Receive Payments menu selection and enter the customer account name in the Received From field; after doing so, you’ll see the message that this customer has available credits
6. Click the Discounts & Credits… button to apply these credits
7. In the Discounts & Credits window that appears, select the credit for $75 that you recorded in Step 3 and click the Done button to return to the Receive Payments window
8. Select the customer invoice being paid and enter the net amount paid by the customer/vendor, along with other payment information such as the Pmt. Method and Check #
9. Click Save & Close or Save & New to record the customer payment

The account you enter in Steps 2 and 4 doesn’t matter as long as it’s the same account, because the debits and credits reverse each other.  In fact, if you already have a clearing account set up, you can simply use that clearing account in these steps.  These 2 General Journal entries are an effort to post a debit to Accounts Payable and a credit to Accounts Receivable.  Because QuickBooks imposes a restriction that only 1 Accounts Payable or Accounts Receivable account can appear on a General Journal entry, it’s necessary to make 2 entries.

Here are the 2 General Journal entries:

Here’s the process at Step 5:

And finally, here’s our completed Receive Payments screen just before saving the transaction:

We favor the second method – using General Journal entries – for 2 reasons.  First, after completing these steps, you can process the customer/vendor’s check with other checks in your Undeposited Funds account as you normally would.  You won’t need to make a separate deposit for each payment from a customer/vendor in order to maintain your bank reconciliation process as you would if you used the clearing account method.  Second, because General Journal entries appear on the transaction list in both the Customer Center and Vendor Center, you’ll have a well-documented trail of what took place.  On the vendor account, you’ll see a bill for $75 and a General Journal debit for $75 that pays the bill; on the customer account, you’ll see the $100 invoice, the $75 General Journal credit that reduced the amount owed, and the $25 payment.  In contrast, in the clearing account method, you’ll only see the vendor bill marked Paid.  You won’t see the transaction that actually paid the vendor bill, which can lead to confusion after the details of how the transaction was recorded are forgotten.

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