I know of someone who is facing a prison term of perhaps ten years and a $500,000 fine because of inputting financial information “incorrectly” in QuickBooks. This individual is an enrolled agent with years of accounting, QuickBooks, and tax experience.
Upon receipt of checks from clients and upon making a bank deposit, the individual would open the customer payments window in the customer menu in QuickBooks, select the client, record the date, amount, and number of the check, and post the entry. The result of this entry was a debit to undeposited funds and a credit to the client’s accounts receivable account for the amount of the check.
After he recorded the payment from the customer, he sometimes would enter a statement charge to the client, typically at the end of the month after all services were provided or when he had the time to do his billing.
You might wonder why he entered some of the payments from the clients first before invoicing or charging these clients. Timing. Accountants often record financial events as they occur. The receipt of the check precipitated its posting in QuickBooks. His billing or performance of services prompted his recording of the charge to the client in QuickBooks. Some accountants require a payment in advance of performing services. Others require a monthly installment for ongoing work. Upon completion of those services and when one has the time to do billing, one would then record the charge to the client.
The problem is a limitation in QuickBooks. After a customer payment has been recorded in QuickBooks, if an invoice or statement charge is then entered for that customer, although the payment is recorded in the accounts receivable ledger for that client, it is not associated or applied to that invoice or statement charge. There must be a charge or invoice already posted in the accounts receivable ledger prior to the entry of the customer payment for it to be applied. Although revenue is credited for the invoice or charge, and the client’s accounts receivable reflects offsetting debits and credits to his account, an invoice or charge remains open in QuickBooks: that is, QuickBooks is unable to associate and apply the payment to the invoice if the payment has been posted into QuickBooks prior to the invoice or statement charge.
What is the result in QuickBooks if a customer payment is recorded prior to a customer charge? Cash is appropriately debited for the correct amount. Accounts receivable for the customer has been debited and credited for the charge and payment, respectively. And revenue has been credited for the services charged to the client.
If we open the accrual basis balance sheet and P&L reports in QuickBooks, the balance in cash, accounts receivable, and revenue are correctly stated. However, if we open the cash basis balance sheet and P&L reports in QuickBooks, accounts receivable will have a negative balance and revenue will be understated: both accounts will not include the invoice or statement charge since QuickBooks has not applied the customer payment to it, and the QuickBooks cash basis P&L report excludes all revenue and expense postings that have not been associated with payments.
The trained accountant, unaware of this limitation in QuickBooks, mistakenly relied on his cash basis P&L report to prepare his Schedule C on his Form 1040, and, as a result, understated his taxable income. Consequently, he now faces a prison term for not entering his client charges prior to his customer payments in QuickBooks. The IRS’s position is that QuickBooks users should know how to use QuickBooks and that if such errors as the one mentioned above occur, then the IRS presumes that they are fraudulent, involving willful intent on the part of the user. Acts of fraud are punishable with prison sentences in addition to monetary penalties.
But the IRS’s position of willful intent on the part of the accountant because of its presumption that accountants should know how to use QuickBooks appropriately appears to me to be unjust. I searched the Intuit book’s on QuickBooks for the years under audit and was unable to discover a caveat warning the user not to enter customer receipts prior to invoicing. Nor could I find any explicit warning in the QuickBooks program during the entry of customer payments and statement charges. In the real world of accounting, often the receipt of customer payments precede the act of invoicing the customer. And one’s accounting system should reflect financial transactions as they occur in time.
So QuickBooks user, proceed with caution. Learn the program to stay out of jail. And take heed before ever entering your customer payments prior to recording their invoices or statement charges!