Free services provided by your business, free passes and complementary service i.o.u’s should NEVER be reported in your books as a “discount” to revenue, nor should they ever be reported as an “expense”. Doing either is an IRS auditor’s wet dream. However, if you want to simply track the value of your free services, coupon redemption or free passes given and redeemed, keep reading, there is a simple solution. Reporting free services as expenses or revenue discounts would illegally reduce net income (net taxable income). That would be great if you could get away with it, but under audit you’d lose. If you give away free goods, or if free goods or incidental items are included as part of a free service, you’d expense the goods at cost or LCM (and reduce your inventory accordingly), but, again, there would be no expense or revenue discount entry for the actual free service – never, ever.
To track service giveaways, create a liability account called, for example, “Free Passes Given” and a second liability account (to be used as a contra liability) called “Free Pass Redeemed”. You can name the accounts anything that you like, but you must ensure that both are categorized as liability accounts. At the time when you begin providing a free service or you issue free passes or i.o.u.’s for free services, you would credit the “Free Passes Given” account and debit the “Free Pass Redeemed” account for the standard $ amount that you would have charged for each service unit or free pass given. When the service is completed, or when a free pass is redeemed, you’d debit “Free Passes Given” and credit “Free Pass Redeemed”.
Example (Free Passes): A skating rink sponsors skating races and gives away a total of 20 free entry passes to the 1st, 2nd and 3rd place finishers. Normally the rink would charge a $3 entry fee per person (per pass). To account for the free passes when given to the racers you would credit $60 (3 x 20) to “Free Passes Given” and debit $60 to “Free Pass Redeemed”. At a later date, when one of the racers redeems a free pass, you’d credit $3 to “Free Pass Redeemed” and debit $3 to “Free Passes Given”. At any time the credit balance of “Free Passes Given” would be the amount of outstanding passes not yet redeemed; the credit balance of “Free Pass Redeemed” would be the total value of passes that have been redeemed.
If you provide a free service and do not issue free passes or service i.o.u.’s, but you want to track your time/forgone revenue for free services, you’d use the same method as provided in the magazine clipper coupon example above; to calculate the correct credit and debit entries, you’d simply multiply the number of complementary hours worked X your hourly rate and and use the same method for reporting flat-fee based services.
You may wonder, why use a liability account to track free services? Two good reasons are as follows: 1) The passes (or agreement to provide a free service) are liabilities of sorts (you are liable to provide the service promised). 2) Use of a liability and contra liability account will ensure that, at any time, you will have an accurate and timely record of all passes issued and of all passes redeemed, without ever accidentally making confusing entries into your asset or equity accounts, or falsifying your balance sheet, income statement or statement of cash flows.
If a customer present you with a discount coupon, you would NOT use the above method. You would complete the following:
Example (coupon redemption): Bob owns a carpet care business. For a job that he just completed, he would normally charge $200; however, the customer presents a $50 discount coupon that she clipped from a magazine ad. Bob would report a $200 (cr) in his normal revenue account and $200 (dr) in his normal receivable account; $50 (dr) in a contra-revenue account called “Coupons Redeemed”, a $50 (cr) to a contra-receivable account called “Coupon Discounts”. When the customer pays $150 for the discounted service, Bob would record a $50 (dr) to the contra receivable account, and $150 to his bank account (dr). At any time, including at year end when preparing taxes, the debit balance in the “Coupon Redemption” account would be total discounts provided to-date.
Note that in a Nevada, Texas, Washington and Ohio, state income tax is calculated as a small % of gross income; all other states and the IRS tax net income (after expenses). In these four states, and states that have franchise tax, state law may require that you include all free services as part of gross revenue for calculating these taxes. In such cases, review the state’s laws and, if free services are required to be included in gross income, it would be prudent to use the coupon redemption (outlined above) for reporting both free services AND discount coupon redemption.
This should do it. Any further questions contact Troy Bryant, Doorstep Mobile Tax, LLC (Atlanta, GA Metro). email@example.com or 404.786.6309.