The most common questions our team receives from customers relate to revenue recognition. Questions around revenue reconciliations, the impact of sales tax and tips, merchant processing fees, cash transactions, and deposits are commonplace. I’m going to try to break down revenue recognition and the related pieces of the puzzle in simple terms, so you can easily understand how Ceterus handles revenue recognition.
Let’s talk about our method of accounting for revenue, it’s called the Modified Cash approach. First, however, let’s start with the two most common methods of accounting and how they impact revenue recognition.
Cash Basis – Applying this method would result in recognizing revenue when a deposit hits your bank account. Generally speaking, a point-of-sale (POS) transaction today would be recognized as revenue somewhere between one and four days from today due to the delay in deposits (cash or credit card).
Accrual Basis – Applying this method requires two approaches: recognizing revenue when a sale takes place and accounting for deferred revenue (a balance sheet item). For deferred revenue think gift cards or memberships where the service is delivered at a later date.
Modified Cash Basis – This method recognizes revenue when a sale takes place and gives no consideration for deferred revenue. Deferred items are recognized as money is tendered for the sale, traditionally prepaid memberships and gift cards. A sales report from your POS system would be expected to match revenue on your income statement using this method. This method is generally preferred by franchisors and, once understood, tends to make the most sense to customers.
The vast majority of Ceterus customers are on the Modified Cash basis of accounting – however, we do have customers that use the cash and accrual methods as well. In this post, we will focus exclusively on the Modified Cash basis for revenue recognition activities.
Now is a good time to cover what happens when a new customer signs up with Ceterus. We always begin the bookkeeping with the first day of the current year. We also adjust to the Modified Cash basis of accounting for our new customers. This oftentimes requires several “true-ups” to ensure everything is accounted for properly. Almost always, adjustments are made to undeposited funds accounts we utilize (Cash Clearing, Merchant Clearing, and AMEX Clearing). Recall, we do this so reported revenue ties to your POS as this is what your franchisor expects. The adjustments made will have an impact on the profit and loss statement. We utilize either non-operating miscellaneous income or expense to balance out the journal entry. These accounts are used because they do not affect Net Operating Income, which is a key metric business owners should be focusing on when they review their results. These adjustments are related to prior periods, so they need to be excluded from current period Net Operating Income. We will dig in on the undeposited funds accounts as we move through
our process.
Also, I won’t be focusing on a particular POS system in this blog post. Every POS report looks slightly different. Nevertheless, all POS systems should contain a report that summarizes sales for the day, including payment type, sales tax collected and tips collected. If you need help finding the right report we can help.
We will use the following example for the rest of this post as we walk through how revenue is recognized.
Ok, so how does all this information get into your financial statements? One big journal entry is the answer. Don’t worry, I’m not going to talk about “debits and credits” with you. I’ll instead show you what to expect when you look at your financial statement. Let’s start with your income statement (aka profit and loss statement).
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Service sales will increase $1,000
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Product sales will increase $500
Now, let’s look at the impact on your balance sheet. You may already have a question: “If I collected $1,730, why don’t I see $1,730 on the income statement?” Simply put, amounts collected for sales tax and tips are not revenue for your business. Nor are they expenses when they are remitted to the state and the employee. Ok, so where do tips and sales tax show up? You will see them on the balance sheet. They are both liability accounts, which means you owe those amounts to a third party.
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Sales tax payable will increase by $30
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In September, you will remit sales tax to your state and this payable amount will be reduced
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Accrued tips payable will increase by $200
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When you pay your next payroll, tips will be included and thus this payable amount will be reduced
The last question we have to answer is “where is the cash?” Unfortunately, credit card sales take a couple of days to make it to your bank account. We need to account for this delay. Similarly, cash sales can take time to make it to your bank account if you aren’t doing daily deposits. We strongly encourage businesses to deposit cash daily – it helps to prevent theft!
Ok, so how are we going to address this delay in deposits? We have created three unique accounts to address the delay in deposits. They are called cash clearing (undeposited cash/checks), merchant clearing (undeposited Visa/Mastercard/Discover/ACH deposits), and AmEx clearing (undeposited American Express deposits).
On your balance sheet you would see the following:
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Cash Clearing will increase by $100
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Merchant Clearing will increase by $930
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AMEX Clearing will increase by $700
In most cases, your merchant (credit card) processor will deposit funds in your bank account between one and four days after the sale. At that time you will see an increase in your bank account and a decrease in the clearing accounts noted above. The same thing will happen when you deposit the cash sales for the day.
In most circumstances, you can actually reconcile revenue to the penny. You can take the POS sales report and reconcile it to future deposits in your bank account. There are times where this can be more difficult, though. Most notably when the merchant processor takes their fee as part of the deposit (net settlement), versus billing you once a month for their fees (gross settlement). By tracking these accounts, you have visibility to see if shortfalls occur and need to be addressed. Feel free to contact your Financial Consultant if you have questions on these balances.
Revenue recognition and associated deposits can seem overwhelming at first. However, breaking it down into bite size pieces should make it a little easier to digest and understand. If you have questions, please reach out to your financial consultant at support@ceterus.com.
