Accounting for Pass-Through Funds (#333)

The Nature of Pass-Through Funds

Pass-through funds occur when you’re expected to collect cash from a customer on behalf of a third party – usually a government – and pass along the cash to that third party. The usual example of this is sales taxes, where you’d collect the sales tax on behalf of the applicable government, and then remit the tax to them – usually once a month, but sometimes less frequently. In the listener’s case, the company collects vehicle licensing and registration fees from its customers and then passes them along to the Department of Motor Vehicles.

Accounting for Pass-Through Funds

It doesn’t really matter what the type of fee is, because the underlying accounting concepts don’t change. For example, if you’re collecting a vehicle licensing fee from a customer as part of a vehicle sale, then the sale is charged to a revenue account, while the licensing fee is charged to a liability account. We do this in order to keep the licensing fee from being recorded as revenue.

The listener goes on to ask if the licensing fee could be recorded within revenue and then subtracted out as a cost of goods sold. The answer is no, because you’d be artificially inflating the reported amount of revenue. Also, you’d be inflating the reported cost of goods sold. So, no – these pass-through funds should never appear on the income statement. Instead, they only appear in the liability section of the balance sheet as a short-term liability. When they’re remitted to the government – or some other entity – then the cash balance declines and the liability disappears from the balance sheet.

That’s the basic accounting. On top of that, consider setting up different liability accounts for these pass-throughs, one for each type of liability. For example, if you’re collecting vehicle licensing fees and registration fees on behalf of the Department of Motor Vehicles, you might have to report these amounts on different forms, and remit the funds to different government bank accounts.

Best Practices for Pass-Through Funds

That means using one account to store the licensing fees, and another account to store the registration fees. And on top of that, if your business remits these fees to the agencies of more than one state government, then you’ll need separate accounts for each one. For example, if you were remitting vehicle licensing fees and registration fees to the Department of Motor Vehicles for Washington, Oregon, and California, then you should have a total of six liability accounts in which to store these transactions.

Otherwise, you’ll have this hopelessly muddled single liability account that’s almost impossible to reconcile. And if that calls for a lot of pass-through liability accounts, then so be it.

Another issue is that, sometimes, the amount you collect from the customer will be different from the amount that the government is actually supposed to receive. If the amount collected is greater than the amount you have to remit to the government, then you do not – ever – recognize it as revenue. That money is not yours. Instead, the residual amount goes back to the customer.

What about the reverse case, where the amount you collect is too low? In that case, you’ll have to go back to the customer and try to collect the difference. If that’s too difficult, then your business will have to pay the difference. Governments will not accept a reduced amount, so you can’t just send them a reduced payment. If these shortfalls are minor, then it’s best to write them off as a cost of doing business, since it may be administratively more expensive to pursue the customer for payment. If these shortfalls are for large amounts, then you’d better look at your procedures and employee training, to see if there’re better ways to avoid incorrect customer billings.