So far, the essence of the first four notches [see first post in series] were to get income and expenses in the correct periods.
All along, I have tried not to make this overly complex. It was not my desire to turn you into an accountant, after-all. That being said, these “notch posts” are not all-inclusive and therefore, do not cover all accounting principles or concepts. They do however, allow you to improve your bookkeeping so that the reports coming out of your accounting system are more complete and accurate.
With this in mind, in today’s post, I want to look at five of the most common financial transactions that are typically misclassified under the simple cash method of accounting.
Here are 5 Common Classification Issues
#1. Recording Assets as an Expense
This has to do with recording all outflows as an expense inherent under simple cash accounting. So, when the church purchases an item that meets the definition of an asset, it gets coded to an expense account. Expenditures for assets are budgeted as just another expense as well. In a future post, we’ll dive deeper into accounting for assets.
At the risk of stating the obvious, the correct way to record the purchase of an asset is to debit an asset account. For example, when the church purchases a new van, that purchase is debited to an asset account.
On the financial statements, this will be shown on the balance sheet as an asset and on the cash flow statement as a capital expenditure.
#2. Recording Expenses Paid in Advance as an Expense
For example, when the premium is paid for health insurance, the premium paid represents coverage for the coming or future month. The proper way to record this expenditure is to debit a prepaid asset account. Then, in the following month, reclass this expenditure to the expense account. (Practically, that premium amount will always stay in the prepaid account as long as you remain current on your premium payments).
#3. Recording Loan Payments or Capital Lease Payments as an Expense
In both of these two transactions, there’s a principal portion and an interest portion of the payment. The principal portion goes to a liability account typically called notes payable or capital leases payable. The interest portion of the payment should be charged to interest expense.
#4. Recording Net Payroll to Expense
I have seen churches that record all payments related to employees and the related withholding’s payments get charged to the same account. Proper accounting for payroll calls for the gross pay to be recorded in a gross pay account. Furthermore, amounts designated as housing allowance are kept in their own account. As to withholding of taxes, these need to be credits to liability accounts. Subsequent payments to Federal and State governments will clear these account balances.
#5. Recording all Revenue as Income When Received
Essentially, for the church, if a donation is given for a specific purpose, the income shouldn’t be recognized on the financial statements until the purpose has been fulfilled.
For example, a common designated receipt in the church is for a mission trip. The receipts would be recognized as income once the trip has taken place. The receipts in the interim are classified into a liability account. Likewise, all expenditures prior to the trip would be deferred into a prepaid expenses account and reclassed to expense once the trip takes place.
The same thing applies to ticketed events. Income and expense are recognized when the event takes place.
Other common examples would be:
Specific gifts to any ministry for a specific purpose. For example, a gift to the student ministry for a new sound board is received. Defer the income until the sound board is purchased.
Special offerings taken up for Projects, Lottie Moon, Annie Armstrong, etc. Defer the income until the project is completed or the payments are made.
A benefit to adhering to these accounting rules is wild swings in the church’s budget vs actual reporting go away. (Assuming you add designated receipts to budget). See this post.
Conversely, adhering to these rules requires you to include these items in your balance sheet reconciliations or supporting documents. This also helps ensure designated gifts are actually used for the intended purpose.