Techniques for Recording Out-of-Pocket Expenses

by John DaySend Feedback to John DayMore Details about recording out-of-pocket expenses here.

Out-of-pocket expenses are not the same as petty cash expenses in that the money used for the expenses is personal money not business money. The challenge is how to reimburse yourself or an employee for personal money used for business expenses. The obvious way is to write a check to yourself or the employee for the receipts for the business expenditures. When that check is written, you simply code the check to the appropriate expense account.

For example:
DEBIT: Freight $11.50;
CREDIT: Cash $11.50
To record reimbursement to Sally Jones for freight
But what if the amount is your personal money and it is a small amount. It doesn’t seem worth writing a check for $3.42 or some such amount. If you are a sole proprietor, why not save all the out-of-pocket receipts until the end of the month, quarter, or year, and write a journal entry that decreases your Owner’s Draw account?

For instance:
DEBIT:Postage $3.42; Auto $15.00; Office $65.00; CREDIT: Owner's Draw $83.42.
To record out-of-pocket expenses for the month
You have been taking personal draws during the year; however, you used some of that money for business purposes. In reality, you did not take as much out for personal use as you previously recorded, therefore, you are entitled to reduce the owner’s draw by the amount of business expenses.

This same system can work for a partner or an officer of a corporation. For a partner, use the account for partner draws, such as Guaranteed Payments for the credit. For an officer who takes advances on salary, use the Officer Advance account for the credit.
A tip for partners of a partnership in the U.S. is to make sure that you include in your partnership agreement that out-of-pocket expenses will be reimbursed directly to the partner. U.S. tax law requires that this procedure be stipulated in the partnership agreement for out-of-pocket expenses from the partners to be deductible. Besides, if a partner does not get reimbursed for out-of-pocket expenses, he will have to report them on Schedule A of his 1040 tax return as a miscellaneous itemized deduction to get a tax benefit. The problem with doing things this way is that miscellaneous itemized deductions are reduced by 2% of the individual’s adjusted gross income beforehand. This means, depending on the amount of your adjusted gross income, you are going to lose part of your deduction. Better to let the partnership take the full deduction for your out-of-pocket expenses.

Keywords: journal entry, recording, out-of-pocket expenses,
About the AuthorJohn Dayjday@reallifeaccounting.comMore Details about recording out-of-pocket expenses here.
John W. Day, MBA is the author of two courses in accounting basics: Real Life Accounting for Non-Accountants (20-hr online) and The HEART of Accounting (4-hr PDF). Visit his website to download for FREE his 3 e-books pertaining to small business accounting and his monthly newsletter on accounting issues. Ask John questions directly on his Accounting for Non-Accountants blog .