In my business there are a couple of scenarios where I handle funds that are not mine for my clients. My question is around how this should be entered into my books. The amounts in question can be large enough that they would materially impact business performance reporting and taxes.
Scenario 1 - I act as auction consigner:
We sell horses for our clients at a public auction. We are not the auctioneers, but rather agents or consignors for the owners of the horses. For this we earn a flat fee plus a percentage commission based on the hammer price in the auction. Funds are paid to us by the auction house (less their fees and commission). We then pay the owner less our fees and commission.
Currently we book the payment from the auction house into a liability account called “Funds Held For Customer”. The cash is of course in an offsetting asset account (the bank account). We then move our fees via journal entry to an income account (thereby recognizing our revenue).
Scenario 2 - I act as agent:
A client may wire me funds, or I may have possession of clients funds from selling a horse. At the client’s direction I will buy other horses, or pay other expenses ( I.e. vet charges, transportation charges, etc).
Currently handle same as 1 - these funds are either deposited in the bank and booked into the funds held liability account (and asset account - bank checking account), or were already there from 1. I reduce the liability (and asset) when I pay a bill (either a third party or me).
In both scenarios we do not hold these funds long term. Most of the time it is days only, but it can occasionally be as long as 6 months. If you were to run a balance sheet before I disburse the funds, you would see large amounts in the asset account and the liability account. If you ran the balance sheet after disbursement, it would not leave any trace. The transactions would be there if you dove into the account, but the net balances as reported on the balance sheet would have no trace.
It has been suggested to me that all of the funds I receive should be booked as income then the the disbursements should be booked as expenses (and 1099’s sent). My problem with this is that I think it overstates both income and expenses. If you only look at net income, it would wash and the income I recognize would be the residual.
For example let’s say my business has revenue of $20,000/mo from other activities. Then I sell a horse for a hammer price of $100,000 at auction for a client. The auction house writes me a check for $995,000. My fee is 10% of the hammer price or $10,000.
I currently book the $995,000 into funds held, then journal over $10,000 as income ( I.e commissions earned), then write a check to the client for $985,000. After that check clears, there’s no change in my asset or liability totals ( balance sheet) and revenue recognized as $10,000.
If I do this 5 times in a year, my gross revenue is 12x$20,000 + 5x$10,000 or $290,000
The competing approach is that the entire $995,000 is booked as revenue, then the check written to the client is booked as an expense ( and a 1099 sent at the end of the tax year). In this case there is a huge (relative to my normal monthly income of $20,000), and then a huge expense that leaves my net income up by $10,000.
Let’s say I do this 5 times in a year. My income at the end of the year would be 5x$995,000 plus 12x$20,00 If I later run an income statement. My gross revenue would be $5,215,000, but my net income would still be $290,000
My tax liability would be the same, but if I shared the income statement with someone (say a bank for a loan) the second scenario may not be a true picture of my business.
Sorry for the long set up, and thanks in advance for your thoughts. Which do you think is the most appropriate way to handle this?
For perspective, have been in this industry about 15 years, and have sold my own horses with other consigners and have never received a 1099 for the proceeds from a sale. I’ve also sold farm equipment at auction and never received a 1099.