Bookkeeping – Suspense Accounts (Lesson 55)
When bookkeepers face an unknown variable with a transaction and don’t know where to place the debit or credit, they use a temporary account to hold the value. This is called the ‘Suspense’ account. There is a suspense account for each of the types of accounts. The suspense accounts are created in the chart of accounts and are used pretty much daily with bookkeeping operations.
This lesson explains the purpose of suspense accounts, how they are organized and the process the accountant uses to clear the transaction prior to closing the accounting cycle. Suspense accounts are a handy tool to temporarily resolve problems.
Purpose of Suspense Accounts
Suspense is defined as ‘mental uncertainty’. Even accountants with years of experience come across economic transactions that they just don’t have a clue how to post. To keep the flow of work moving, we temporarily place the value in a suspense account for what we feel is the correct type of account associated with the respective debit or credit. The following are the six types of accounts:
- Assets
- Liabilities
- Equity
- Revenue
- Cost of Sales
- Expenses
Remember each type of account has a normal ending balance and is associated with either the balance sheet or income statement. As an example, I once came across a transaction whereby the owner received cash for the sale of a convertible note. Well, technically he couldn’t issue convertible notes as this is considered a form of equity (a class of stock) and the company held S-Corporation status with the IRS. S-Corporation status limits the company to one class of stock. I temporarily posted the credit to the suspense account in liabilities. I discussed the matter with the owner and his legal counsel to resolve the correct form of the transaction.
This same form of questionable orientation and meaning with transactions will happen with all businesses. In small business it occurs regularly. When the transaction is entered into the journal use the suspense account in the interim until it is resolved.
Technology Tip
QuickBooks uses an account named ‘Ask My Accountant’ located in the expense type of accounts. It is customarily the last account in the chart of accounts. Instead of six suspense accounts, they simply have one. This is acceptable, but please do not print any reports unless the account is completely cleared at the end of each accounting cycle. I encourage six suspense accounts, one for each type of account as this prevents an accidental misunderstanding of financial status during interim accounting periods.
Organization of Suspense Accounts
Set up a single suspense account in each type of account and locate the account as the last account in each of the six major types except for liabilities (explained below). The following is each account type and the location of the suspense account and the corresponding reason for the structure.
Assets
The assets section of the balance sheet is divided into three groups of assets: current, fixed and other. The suspense account for assets is customarily created and placed in the ‘Other’ group of assets. The reason it is placed here is to minimize misinterpretation of current and fixed assets.
If the account is placed with current assets it will greatly affect formulas such as current ratio, quick ratio, working capital and liquidity. Placing the account in fixed assets affects matching of values to depreciation schedules and financial sources. The most conservative location is in ‘Other’ assets. There is less reliance on value and therefore minimal misinterpretation.
Liabilities
The suspense account for liabilities is the anomaly in the pattern of where the account is located. Since liabilities are divided into two distinct groups of short and long-term, the more conservative approach is to place the suspense account in the short-term group. Similar to functional placement, make it the last account in short-term liabilities.
Yes this does negatively impact current and quick ratios, but it is best to err towards conservative misinterpretation.
Equity
Equity is divided into three major groups. They include initial capital contributed/invested; retained earnings and corresponding distributions/draws and current earnings. Since any form of equity suspense is a current issue, the suspense account is located in the current earnings area of equity on the balance sheet.
Revenue
The revenue section is actually comprised of two sources: sales and other. Often suspense items for revenue relate to nontraditional sources of revenue. Therefore the suspense account is customarily placed as the last account in this type of account. Surprisingly, over time you’ll discover tha the most common for of revenue suspense relates to returns and allowances.
Cost of Sales
Suspense issues with cost of sales often occur with contractual compliance and the bookkeeper doesn’t understand if the cost is materials, subcontracting or some kind of legal compliance item. As with the pattern explained so far, create a suspense account as the last account within this type of account.
Expenses
With expenses, suspense is the last account too.
Technology Tip
Almost all accounting software programs prevent the creator of accounts to have identically name accounts. For purposes of creating the accounts use the following naming pattern:
Type of Account Suspense Name
Assets Suspense – A
Liabilities Suspense – L
Equity * Suspense – C
Revenue Suspense – R
Cost of Sales Suspense – COS
Expenses Suspense – E
* The letter ‘C’ is used for equity instead of ‘E’ as ‘E’ is used with expenses. The ‘C’ represents ‘Capital’.
Examples Using Suspense Accounts
The following are examples of some common suspense issues I’ve experienced and how to handle the transaction.
Government Payment
The government overpays or refunds overpayments from time to time. Often the checks are mailed well before letters explaining the basis of the amount. When the payment is received, the proper entry is to debit cash for the deposit and credit the suspense account in liabilities. Initially, the bookkeeper’s thought process is that the government overpaid and the company will owe the money back to the government (this happens frequently) which is exactly like a liability. By the way, the underlying culprit is miscommunication with the IRS caused by an improperly filed form.
Unknown Expense
A very common transaction is the owner buying something with either a debit card (cash withdrawal) or via the company credit card. The credit is either to cash or the liability account for the respective credit card but the actual expense is unknown. The debit is made to the expense account ‘Suspense’.
Additional Capital
Sometimes a large deposit is made and the source is unknown. This is usually a sign of a capital investment by the owner(s). The debit is cash and the credit is to the suspense account in the equity section of the balance sheet.
Arbitrary Payment to a Vendor
The construction industry frequently prepay vendors (owners will make a deposit or pay early) for future work. The bookkeeper knows of the payment but not the respective project or phase code. In this case, the debit is to cost of sales suspense account even if using the work in process method of accounting.
Commitment Made for an Asset
As an accountant I always pay attention to corporate physical operations, i.e. I’ll walk the facilities. Invariable there will be a physical asset I’ve not seen before and it is new. I’m also keen to the fixed assets list and know this item isn’t on the list. Basically, the owner has done something by purchasing the asset without informing me or utilizing the proper procedures. Here, I post a $1.00 debit to the assets suspense account and a corresponding $1.00 credit to the liabilities suspense account. This clues me to follow up on the issue in the future.
Clearing Suspense Entries
One of the steps in the monthly closing process (future lesson) is the clearing out of suspense entries. Each of the six suspense accounts are reviewed and each entry is adjusted to the correct or appropriate account. I encourage bookkeepers and accountants to perform this function weekly.
The most difficult part of clearing an entry (adjusting the entry to the correct account) is getting the correct information from the source party (owner, manager or purchasing agent). Once the appropriate information is received the entry can be adjusted for accounting purposes.
Technology Tip
Many accounting programs allow the user to display the transactions for an account limited to a timeframe. In QuickBooks, select reports, accountant’s reports, transaction list and via the custom fields select the six suspense accounts for the current accounting period. It will display existing entries for all six accounts.
To assist you with the process of closing out suspense entries, here are some helpful tips:
- Get Descriptive – When creating the initial entry, get very descriptive in the memo section. State what facts you have and questions to ask. It is often a good idea to send an e-mail immediately to the party with knowledge requesting clarification with the transaction.
- Set a Flat Value Marker – When an economic transaction occurs and you are not aware of the financial value, use a value marker to clue you in that there is no dollar value associated with the respective transaction. This forces you to research the financial value. Some common value markers include $.99, $1.00, $1.01, $6.66 (the mark of the devil) and $7.07. Use a value yo know will trigger your mind as a ‘Dig further into this transaction’ command.
- Complex Transactions – Every now and then a complex transaction occurs requiring the assistance of the CPA. While awaiting a response via e-mail, use the suspense account to temporarily store the unknown element of the transaction.
- Be Proactive – Send and e-mail to the party with the most knowledge of the subject so they have adequate time to respond. It may take several days to get clarification concerning the subject.
One final note about suspense accounts. When the books of record are really messed up, accountants use the suspense account to temporarily hold a transaction when they are clear about one side of the dual entry. The part that is unclear is stored in the suspense account for further review. This form of bookkeeping is explained in detail in the advanced bookkeeping section of this website.
Summary – Suspense Accounts
Suspense accounts are used to temporarily store questionable transactions. There is one suspense account for each of the six types of accounts with the books. The bookkeeper uses the suspense account when there is some uncertainty as to the appropriate account to post the value. After researching the economic transaction, the bookkeeper merely opens the entry and makes the appropriate adjustment. ACT ON KNOWLEDGE.
Value Investing
Do you want to learn how to get returns like this?
Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.
There are four key principles used with value investing. Each is required. They are:
- Risk Reduction – Buy only high quality stocks;
- Intrinsic Value – The underlying assets and operations are of good quality and performance;
- Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
- Patience – Allow time to work for the investor.
If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above.
Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:
- Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
- Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
- Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.
Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:
- Lessons about value investing and the principles involved;
- Free webinars from the author following up the lessons;
- Charts, graphs, tutorials, templates and resources to use when you create your own pool;
- Access to existing pools and their respective data models along with buy/sell triggers;
- Follow along with the investment fund and its weekly updates;
- White papers addressing financial principles and proper interpretation methods; AND
- Some simple good advice.
