Questions from the OWLS: Bank of Bob

There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.

Alicia Katz Pollock: Hey everybody. Welcome to the latest edition of the unofficial QuickBooks accountants podcast. I'm your host, Alicia Pollock of Royal Biz.com. Today's episode is called questions from the owls the Bank of Bob. I'm going to do a new segment starting today called questions from the owls. Many of you know that I have an entire QuickBooks training community@royal.com, [00:00:30] where I teach classes, and there's an on demand recording library where you can go in to ask questions and learn how to do things on the fly. We also have forums that are really active, and there's a constant question that's been coming up over the last couple of weeks about what to do when you have a client who commingles specifically when they incur business expenses, but they're doing it on personal credit cards, for example, or they paid [00:01:00] for it out of pocket with cash. And this is always a challenge because if they don't actually tell you that they incurred the expense, you don't even know. And then once you do find it out, maybe at least they thought to send you the receipt or to tell you about it. How do you enter it? And so that's where the conversation came, comes in about what I call the bank of Bob. So what is the bank of Bob? Bank of Bob is an imaginary [00:01:30] bank account that I add to the general ledger. And I use a bank account because it's funding. And so it's a place to put transactions. And, you know, it's not an imaginary account because the money is getting spent.

Alicia Katz Pollock: So I can't really call it like a fake account, but it is an account that just represents the owner's pockets. Now, if I was being official about it, I would call it personal funds used. Okay. But I like to call it Bank [00:02:00] of Bob because it makes the owners laugh. They get the concept, you know. And so I wouldn't just call it Bank of Bob. Like I'll call it Bank of Alicia or Bank of Gary or Bank of Rachel, whatever the person's name is. And that really gets the point across that it's their own money that they're spending. Now, if you ask a CPA what they do with these investments, they say, oh, well, these are owner investments. And I make a journal entry to show [00:02:30] what the expense was for and then put it in the books, debiting and crediting the expense and the and the equity account. But in QuickBooks, that's not necessarily the best approach. As you know, using forms in QuickBooks is always the best approach to take because some of the reports have automatic filters according to the transaction type. And journal entries may or may not work in those circumstances. Also, [00:03:00] if you do a journal entry, all you're really capturing is the dollar amount and the account category. You you can put on the vendor name, but it might not even show up on the vendor's list depending on how you have your filters set up.

Alicia Katz Pollock: So I really like being able to capture the entire transaction, everything about it. The vendor named the date, the class, the location tags. If you have the tags, the details, the memo, literally everything that you could possibly put on it [00:03:30] gets captured normally. And the only way to do that is to assign it to either a checking account or a credit card. So that's where Bank of Bob comes in. By having an account called Bank of Bob, it gives you a place to enter your real expense transactions, and it doesn't matter if they're paying by cash or by debit card or by credit card or by check, however they paid for it. Personally, you only need one account because by the time it hits the business, [00:04:00] it's just owner equity anyway. So it's just really a dumping ground for all of these extraneous transactions. When I say extraneous though, it doesn't mean they're not material. I just mean outside the norm. Now, of course, we don't want them commingling. We don't want them using personal expenses, but sometimes they forgot to bring their business card or they pulled the wrong one out. Because, you know, my two southwest credit cards look exactly the same for my business account, my personal account. [00:04:30] So I actually have to turn it over and look at the back of the card every single time. Or if I'm doing tap to pay, it pulls up the cards and sometimes I miss tap and I wind up tapping my personal card instead of my business.

Alicia Katz Pollock: Well, I don't really I don't make this mistake, but it would be possible. And I can see how people do make that mistake. So once you have created your workflow where they at least got you the receipt or told you about the expense or [00:05:00] entered it themselves, they basically can use regular Transactions in order to enter it in. So they can use an expense or they can do as a check, or they can do a bill and a bill payment if that's what your workflow is, even though this is usually retroactive and you don't need the two step process. But let's just say you use an expense so they get to put in the expense with everything about the purchase itself. And then you use Bank of Bob as the funding source [00:05:30] for it. And so you basically have a checking register of all of their personal expenses that they've incurred. Then what I do at the end of the month or the end of the year, if there aren't very many of them, is I'll make an adjusting entry to owner investment. And so it just gives a lump sum in equity of all of the individual transactions that they've accumulated for the year. This makes it really easy and streamlined. [00:06:00] Your QuickBooks understands how to do the reporting on it, and it makes it clear to the owner how much co-mingling they're actually doing. Now, ideally, you're just talking about one or a handful of expenses a year at the max.

Alicia Katz Pollock: But if you have a business owner whose bank of Bob is full of transactions, you know you've got a co-mingling issue. If that's the case, the best thing to do is to figure out how much are they spending every single month. And instead of using the business [00:06:30] for their personal expenses and their personal for their business expenses, you make sure that you have the right funds in the right place by making lump sum transfers on a monthly basis. So if they tend to put their personal expenses on their business funds, have them move all of those Spotify subscriptions and Hulu subscriptions and even their PGE bill, their electric bill over to their personal and then take a monthly transfer out [00:07:00] that covers all of those bills. So, you know, the the grand total dollar amount is all still the same, but it doesn't look like they're pulling. Tons of money out of the company. And then when we're talking about owner investments, if they keep pulling out the wrong card, then same deal. If it's a matter of them not having enough money in the business in order to make the expenses. So they're funding it personally, the reverse is true. Have them make a monthly contribution to the company. You know, 500, [00:07:30] 1000, 10,000, whatever their scale is. And then that way they have the money in the company and they're not commingling with all of these individual expenses going through them.

Alicia Katz Pollock: Now, when I teach Bank of Bob, one of the popular follow up questions is, what do you do if the owner is planning to pay themselves back? If you're using Bank of Bob, that's great. The the paying back just pays [00:08:00] down bank of Bob. And you just categorize it straight back to that account and ideally it washes to zero. And then that way you don't have to make the adjusting journal entry to owner investment. What you don't want to do is have constant new transactions show up and constant payouts. That's when you know that you've got somebody who really needs some better fiscal management. If we're talking about loans and the business owner is loaning themselves money, then [00:08:30] I don't use Bank of Bob for that. I do a shareholder loan as a liability. And then every time they pay themselves back, I pay down that liability until it's zero. If it's material, you actually have to go a step further. If they are loaning the company money, like let's say $10,000, then they actually need a promissory note and terms and they even have to have reasonable market interest on it. So you have to have a contract in order to make that legal. [00:09:00] And that's one of those steps that a lot of business owners don't want to admit to themselves that they are loaning themselves this money. And so you have to make sure that you have some structure around it. So if the owner is loaning the company money and it is structured as a loan, it has to be really an official loan.

Alicia Katz Pollock: And you do have to file a 1099 K on the interest. A related topic to this is managing owner equity in general. Quickbooks [00:09:30] out of the box doesn't have any owner share, owner draws or investment accounts, and you do have to put them in. And the terminology that you use depends on the formation of the company. You know, are they a sole proprietor? Are they an LLC? Are they a partnership? Are they an S corp? If there's only one owner, then you make an owner draw an owner investment category. And if it's a sole proprietor, that's the terminology that you use. Drawers for the money [00:10:00] out and investment for the money in. Once you get into any of the other entities, I prefer distribution and contribution instead. If there's more than one owner, then you actually need an owner equity section for each owner. And in that owner equity section, you need it each person's own distributions and contributions. And if they're partners, then they have a partnership agreement that talks about their percentages. Are they 50 over 50? Are they 75, 25 [00:10:30] is one an equity partner and one is the labor partner. And when that's the case, you actually have to keep an eye on whether they are meeting their proportions, that at the end of the year, you might have to chew them up where one person has to put in or take money out of the company so that they are equal.

Alicia Katz Pollock: Now, at the end of the year, on December 31st, like I said, you want your bank of Bob to be zero, and you do that by transferring [00:11:00] the balance to owner investment. But there's also another step when I'm doing my year end review after taxes are all filed and everything is all hunky dory. One of the last things that I do to close the year is I zero out those owner equity buckets. I'll take a look at what's in the owner drawers or distributions now, because it's the end of the year when I'm looking at a balance sheet, and especially when it's a balance sheet, that's year over year over year. I want to see what [00:11:30] they drew out on an annual basis. And just naturally your owner draws and your owner contributions over time, just year over year over year because they accumulate. But it's really helpful for me to be able to see this year, they took out way more than they did last year, or maybe they made less on their owner contributions. So I really like seeing the seeing them happening. So what [00:12:00] I basically do is on January 1st of the following year, you zero out those distribution and contribution accounts. We don't do it on the 31st because then everything would be zero and you wouldn't have anything to compare. So we do it on the on January 1st, and then that way it resets for the next year.

Alicia Katz Pollock: So I take whatever is in the distribution's account and I move it to retained earnings. And whatever is in the contributions [00:12:30] account, I move it to retained earnings because your retained earnings is the cumulative of all of the money that the company has earned. But if the owner has put in some money or taken some money out, it directly affects that retained earnings. So basically what it looks like is let's say it's my owner draw. Then I'll credit the owner draw on January 1st for whatever the total was on December 31st. And I'll debit retained earnings. And [00:13:00] if it's the contributions it goes the reverse. It goes the reverse. I will I'll debit the contributions and credit the retained earnings. Now, if you really want to go deep into this topic, I have a whole class on it in my accrual accounting class. But I did mention what happens with different entities, sole proprietors and LLCs and partnerships. So it would be kind of unfair to leave you hanging without without talking about it. So as I mentioned, when you're [00:13:30] doing these clearings at the end of the year, if it's just a sole proprietor, you can close straight to retained earnings. Really, they have no retained earnings. It's just owner equity because a sole proprietor is the company and the company is the sole proprietor. If it's an LLC or a partnership and you have multiple members, then you would distribute these draws and investments out according to their percentages.

Alicia Katz Pollock: So if they were lump sum together, like [00:14:00] I mentioned earlier, you're better if you have multiple members to actually put each person's distributions with that individual person, and then just compare to the ratio that they're supposed to have, and then true it up. And then if it's an S corp, it's just retained earnings. It's just what it is. Now while I'm talking about Bank of Bob, I should probably talk about bartering as well because I find a lot of that bartering is when you're trading [00:14:30] goods or services with a client, it might be business to business where you're trading business services. It could be you're providing bookkeeping and they are paying you with chickens. So there's a business and a personal and it could be them doing the business service for your business, but you're paying them with something personal, like maybe you're an artist and you give them a piece of art. The thing with bartering is that it is business activity, and it does count [00:15:00] as income, and it does count as tax deductions. And if you are doing it under the table, you may think to yourself, oh, well, I'm keeping it off of my books, but that's actually a red flag. It's technically illegal. Not only does it flag you with the IRS indefinitely, but it also means that you're undervaluing your income and your company in general. So let's say you were applying for a bank loan.

Alicia Katz Pollock: You would want to see that total income that you would have earned. [00:15:30] And when you're filing your taxes, of course you want as many deductions as possible. And bartering is also 1099 able as well. So you're still paying and getting paid. It's just not with legal tender. It's with other trades and services. So as far as the how to do this in QuickBooks, if it's a straight trade, you can just do this through a $0 check or a $0 [00:16:00] sales receipt, depending on whether you are receiving the income or the or incurring the expense. And so basically you put in the expense as let's say you're doing it as an expense. You would put in the expense as normal, and then you would subtract the income category or the product or service that you're trading for. And then a negative expense is income. So it works perfectly well. Or if it's a customer and you [00:16:30] are providing services for the customer, but they are paying you with their services, you could do the same thing with the $0 sales receipt, where you're tracking the product or service that they are getting from you, and then you subtract your expense category. Now you do have to make a product or service that is double sided, meaning it can show up as an expense in order for it to work. But if you subtract an expense on an income category, then you incur that expense. So it works really, really nicely.

Alicia Katz Pollock: If [00:17:00] either side is personal, you would use owner draw or owner investment as the offset. But having a $0 sales receipt or a $0 check means that the income and the expense are included on all of the different reports. So it works really nicely. Now all of that works really well if the barter is just straight across. But what if there's an unequal value and there's several activities involved, then doing it in your memory gets really, [00:17:30] really complicated and really hard to ever know who owes who. And so what I do is I create in my QuickBooks a bank account called barter clearing. So it's kind of like Bank of Bob, but it's just for the barters. When you are doing it this way, you do need to use a customer and not a vendor because the reports only work on the customer side. And it doesn't matter if you are having an expense with the customer. That part's totally fine. I [00:18:00] also create a payment method in the payment methods list for bartering, so that I can track them that way as well. Then what I basically do is incur the income as normal and deposit the sales receipt into the barter clearing account, or I would incur the expense as normal and put the expense in the clear as being paid by the clearing account. And then that way you can see their exact balance. You can even run a report drilling [00:18:30] into the balance sheet, into the barter clearing and see all of the barters.

Alicia Katz Pollock: And then when they're equal, when the money in and the money out are satisfied, then it equals zero. So I do this, um, this extra little trick that after a barter is finished, I'll reconcile the barter clearing account and all the money in and all the money out. All of the trade offsets each other and equals zero. And then in that report, I actually [00:19:00] filter the report. So it only shows me transactions that are not reconciled. So you find filter and then you do status and you say not reconciled. And then you see all of your current open barters and the ones that are complete fall away. So it's a very elegant solution. So those were some big topics in the Royal Wise Owls for the last few weeks. The bartering section is in my class called Tricky Situations. And Bank of Bob is in my class called Accrual [00:19:30] accounting. Both of those are 3 to 4 hour classes with like everything about all kinds of these complicated situations. But I thought I would share some of these takeaways with you. Um, because the Bank of Bob in particular really, really, really makes it easier to manage all of those personal, personally paid expenses. If you're interested in seeing it all in action with actual demos of how to do these things, definitely [00:20:00] check out the classes and I will have the links in the show notes. This is Alicia Pollock and I will see you in the next one.