Clearing accounts are a valuable tool used for creating transparency and better problem-solving methods in corporate accounting, especially in payroll and with cash payments. But when is a clearing account necessary, and why do they matter? How are clearing accounts best used, and by whom?
It’s easy to fall under the misapprehension that business money is doing one of two things – coming in or going out. There’s a third category: Limbo. When in limbo, money is waiting for account attribution or has yet to be cashed or received. Sometimes these funds are tracked through a temporary account, a way station of sorts. Popularly known as the “clearing account,” these are also often referred to as wash accounts, barter accounts, zero-balance accounts and even just temporary accounts.
What Is a Clearing Account?
Clearing accounts can sometimes be confused with “suspense accounts” – understandable since they’re both temporary accounts waiting for more information before a next step can happen.
Where they differ is that a suspense account is all about solving a mystery or problem. Perhaps some client has paid off several things at once in some lump sum and there’s some struggle in deciphering how that payment breaks down. The payment goes into the suspense account until this is resolved and it’s understood where the money belongs.
The clearing account, however, is much like a general ledger used as a reminder for services or goods received or sold that have not yet been billed, or other transactions which can’t yet be recorded in detail. At times, it’s used as a way to track an ongoing project, say an office renovation where bills are being submitted periodically but which need lump payment to a general contractor at a later date. Once the payment is due and made, it can be posted in the correct accounts and cleared from the clearing account.
Another example is a company working on fiscal year-end books. They may park revenue and costs related to this project in the temporary or clearing account until the review is complete. At that point, they can transfer said revenue and expenses from the clearing account to their net earnings.
When a Business Needs a Clearing Account
Volume generally has a lot to do with needing clearing accounts. Say there’s payroll to contend with. The payroll clearing account should be a zero-balance account. Just after the payments are tallied, before they’re issued to employees, payroll funds are transferred into the clearing account. When they’re cashed, the account reverts to zero and all the payments are registered.
Perhaps there’s a company that does a lot of cash business, like a junking service that collects from people all day long and receives cash at every stop or two. This proprietor could use a clearing account to quickly record transactions and cash until he can properly record and allocate funds to their correct accounts at day's end, or the end of the week.
When there’s a steady stream of income coming in or going out, a clearing account can be helpful in keeping track of what’s in transition or will need to be reckoned with in the coming weeks.
It’s important to note that the whole point of using clearing accounts is to make life simpler during the transitional phase with money. If one uses just a single clearing account for all sorts of transactions, it defeats the purpose.
A company should instead have a payroll clearing account and another for managing expenses, and so on. By doing so, monies are kept in their proper categories for easier problem-solving and monitoring as needed. There is no limit to how many clearing accounts a company can use in accounting practices since they’re zero-balance accounts not intended to show on final accounting ledgers. It’s all about what makes sense for recording transactions and making books balance.
How to Set Up a Clearing Account
Setting up a clearing account depends on where you’re doing it. Say Quickbooks is your software of choice. Open “lists,” then select “Chart of Accounts” and right-click anywhere in here, then select “new.” There should now be an “add new account” window, so select the “bank” button. Quickbook notes that there are several account types to choose, but “bank” is the best for a clearing account because of the flexibility it offers.
“Bank” allows you to pay into the account using “receive payments” or “make deposits.” When paying out, you can use “write checks” or “pay bills.” Another plus is that the bank account will be a balance sheet item as well as a cash flow statement, showing as balances and also changes in balances.
Then there’s the practicality because allocating expenses to overhead or class using zero checks means needing a "bank" account for the clearing account.
But, back to creating the clearing account: Once you’ve selected “bank,” hit “continue” and now enter a title in the account name field – clearing, barter, wash, temporary are all good names for this account, and perhaps for what department. Such as, "payables clearing account."
Do not enter an opening balance now. Just save it and close.
But Wait, There’s More
Each accounting software offers different options and account controls. Their product support will have steps listed for installing clearing accounts for that system. If your company is a small business and you employ outside services for year-end accounting, it’s wise to consult your accountant to see what she suggests as the best way to prepare clearing accounts for your business's needs. She can list what categories of clearing accounts would benefit your operations.
Whether you use Bill.com, uCollect, Xero, MYOB, Freshbooks or any other accounting system, their support pages will explain how to start clearing accounts, because they’re so fundamental to most business accounting practices. Some cloud-based accounting software and even Quickbooks have third-party plug-ins that give bespoke clearing account solutions that may be worth investigating.
Staying Accountable with Clearing Accounts
Clearing accounts are terrific for managing the money flow and staying on top of cash traffic patterns. But all of this can go awry if there is no one accountable for keeping the clearing account current.
A clearing account should be reviewed monthly. Reconciliation is a critical role in clearing account success. Without reconciliation, clearing accounts are anything but clear.
A month is plenty of time for you to designate an operations account for each transaction listed in the clearing account. That’s sufficient time for transferring the right funds to said accounts for these entries.
Anything leftover in the clearing account after this duration is a transaction that needs chasing down. Such as, why isn’t that check being cashed by a vendor? Was it even received? If not, it could monkey with the company’s ability to receive stock or attain needed services in a timely manner.
Ensuring checks are cashed, not just receiving deposits, is part of being a successful business. After all, when service providers realize you’re accountable for money coming and going, it creates better working relationships for the long haul, because they know you're paying attention to repaying them for their services.
How to Write Clearing Accounts on a Balance Sheet
Payroll is a popular use for a clearing account and it’s a great example of how a clearing account functions.
Like any clearing account, payroll clearing accounts are a zero-balance account. Because of the year-to-year nature of payroll and how things can change so frequently in withholding taxes and other deductions, it’s great to use a clearing account to help reconcile these things. And, when errors happen or adjustments need to be made, it can be a more straightforward process to resolve when it’s in a work-in-progress clearing account versus a line item in A/P or A/R. That’s why accountants love using clearing accounts – it helps avoid messy entries elsewhere.
- Wages $22,476
- Worker’s Compensation $1,348.56
- Employer Taxes $4,719.96
- Payroll Fees $77
- Clearing account balance $28,621.52
All these sums are listed as a debit on the left side of the accounting ledger. The clearing account balance is the total of wages, worker’s comp, employer taxes and payroll fees – all monies involved in the dispensing of wages.
On the right side of the ledger, a credit is listed as $28,621.52, the same as the total for the clearing account wage-related monies.
Once the paychecks are cashed, the sum should tally up to $22,476, and this can be reconciled to zero. When the worker’s comp payment goes to the government, that becomes zero. Likewise for tax submissions and paying the payroll services.
So, as each line item is cashed out or paid out throughout the month, or at month’s end, it’s reconciled, and after it's all said and done, the clearing account should return to a zero balance. This is where the term “zeroing out” comes from – it’s what the result is as clearing account items are reconciled.
How to Note Clearing Accounts on QuickBooks
The Intuit team behind Quickbooks has made using clearing accounts a fairly simple procedure.
First, create a Journal Entry and then add the A/R or A/P account from which you are moving money. Now add the clearing account. Save this Journal Entry.
Then create a second Journal Entry and add the clearing account to this entry. Next, add the A/P or A/R account to which you will move money.
Finally, in “Pay Bills” or “Receive Payments,” link these two Journal Entries together.
When Zero Balances Don’t Happen
Whether used for payroll, accounts payable, cash transactions needing later resolution or receivables, clearing accounts almost always have to return to zero after transactions come in and go out. When clearing accounts don’t reconcile to zero, it causes problems that ripple out into the general ledger.
Reconciliation is the same as with other accounts. If payments come in that don’t match up dollar for dollar, it’s important to ask why. If payments go out for incorrect sums, that needs to be solved. If checks aren’t being cashed, it’s time to get them cashed. All of this goes into reconciling the clearing account. When correct totals are zeroed out, then the clearing account will hit a zero balance and the process of clearing can begin anew.
When small companies are involved, clearing accounts can have downsides. If there aren’t enough transactions to justify adding this layer of transparency and redundancy, then it can be extra work that’s unnecessary. Unresolved entries that are off by pennies and dollars can create more hassle than they’re worth, but staying on top of this on a week-to-week and month-to-month basis can keep these to a minimum.
Also, it’s possible that it can have a negative impact on the bottom line for small businesses, too. It may be that transferring funds into a clearing account can mean losing interest gains on corporate savings, which isn’t likely to be a large sum, but doesn’t every penny count in small business health?
Ultimately, clearing accounts can be a tremendous tool for many companies. Whether clearing accounts are beneficial for your firm comes down to the volume of transactions and how many hands are involved in the corporate accounting. If you’ve sought better transparency and cleaner accounting ledgers, clearing accounts could be the solution you’re after.