How Service Agreement Escrow Accounting Works
This feature allows you to only recognize service agreement (SA) income when you perform the work for that SA. If you sell a service agreement for $200.00 and there are two work orders (two visits), you will recognize $100.00 of income for each work order. The income is recognized automatically on the date of the work order, when that WO is marked as “Completed”. You can also recognize service agreement income on a monthly basis, regardless of any work order activity.
A More Detailed Explanation
The up-front money collected on service agreement is set aside and held in a liability account, pending fulfillment of the actual work promised in the agreement. Once the date of a planned maintenance work order has arrived, then a certain amount of money held in the escrow liability account is recognized as income. This process prevents all of the prepaid cash from being recognized as income prematurely. This method adheres to accrual accounting principles.
For example, imagine the sale of a two-visit service agreement. The prepaid funds received from the customer is not yet truly income because no planned maintenance visits have taken place. If the customer canceled the agreement before completion of any maintenance visits, we would be liable to the customer for their prepaid money. It is only after each planned maintenance visit date has arrived, that half of the collected money can truly be recognized as income. Until the condition of performing a maintenance visit has been met, the money is kept in an escrow liability account.
Fun Fact: In the specialized area of Cost Accounting, this concept is often referred to as Billing in Excess of Work Performed.
Income Recognition Methods
To recognize SA income, Total Office Manager creates a special adjusting journal entry called an “Escrow Movement”. The date of income recognition is controlled in two ways. You set this method on the Service Agreement item > Accounting tab > Escrow Methods selection.
- Match Movements to Work Orders: Service agreement income is recognized automatically on the date of the work order (the date in the Date field), when you set the work order to “Completed”. Changing the work order date will also change the date the income is recognized (the escrow movement date is changed).
- Create Monthly Movements: You also have the option of recognizing the service agreement revenue on a monthly basis. The amount of the service agreement is divided evenly by the number of months in the service agreement. This option can be set on each service agreement item. You can use both income recognition methods.
How to Activate SA Escrow Accounting
The Escrow Accounting feature must be enabled prior to use. This is done in the Service Agreement area of system preferences. Access system preferences from the main menu by clicking Edit | Preferences. See the related topic, “Preferences – Service Agreements” for more information.
When the Escrow Accounting feature is enabled in system preferences, a warning is displayed (see illustration below). This warning advises that escrow accounting is an advanced feature and should only be used after consulting an accounting expert. The Escrow Accounting feature is intended for users who have a solid grasp of accounting. It is strongly recommended that the Escrow Accounting feature be completely and thoroughly understood before implementation. Read, contemplate, and re-read the information contained herein over-and-over as necessary until total comprehension of the feature is achieved. Misuse of the escrow accounting feature can potentially lead to accounting problems not covered under any support plan Aptora provides.
It is also advised that the Escrow Accounting feature may not be legal in all states and there are tax implications. It is your responsibility to determine the legality of escrow accounting use in your location.
Overview of the Process
After setting up each service agreement as an invoice item, the day-to-day process of using escrow accounting service agreements is not much different than using ordinary service agreements. However, it is extremely important that the proper steps be taken in sequence through completion. The specifics are discussed in detail below, but the basic steps are:
- Sell a service agreement to a customer,
- Create (record) the new service agreement for the customer, and
- Create the planned maintenance work orders for the service agreement, from the service agreement.
Overview of the Escrow Accounting Transactions
The behind-the-scenes transactions which occur when using service agreement escrow accounting are as described below.
- When a service agreement is sold, the prepaid funds are temporarily recorded as income.
- In the next steps, as planned work orders are created, special journal entries, called Escrow Movements, are created automatically.
- One journal entry is created to immediately move all of the prepaid funds from income to the escrow holding account.
- Other journal entries (one for each planned work order) are created which move a set amount of prepaid funds back into income on the date of each planned work order.
These journal entries are the backbone of service agreement escrow accounting. They are listed and managed through the Escrow Movement List. Under certain circumstances it may be necessary to modify these journal entries. Common situations which require this sort of activity are discussed later in this help topic.
Creating Service Agreement Invoice Items
Setting up a service agreement invoice item for escrow accounting is identical to setting up any other service agreement invoice item, with one exception. When escrow accounting is enabled, two additional fields called “Escrow Holding Account” and “Escrow Method” appear on the Accounting tab of a Service Agreement type of item.
Escrow Holding Account: This is where to choose which liability account to use for holding prepaid money when a service agreement is sold to a customer. It is recommended that a separate escrow holding account be used for each service agreement invoice item. This allows the escrow money to be tracked properly in various reports. In many cases the type of accounts setup for this purpose are “Other Current Liability” accounts. Consult your accounting professional if unsure of the account type to use for service agreement escrow accounts.
Escrow Method: Select how you wish to recognize the SA income. Please see Income Recognition Methods above for details on each of the two options.
Selling an Escrow Accounting Service Agreement
The sale procedure of escrow accounting service agreements is identical to the sale of any service agreement until the “Do the Paperwork” reminder appears.
At this point it is critical to continue and create a “New SA” at that very moment. Do not choose to edit an existing service agreement. Do not cancel, with plans to finish the paperwork later. The only way to properly create the journal entries necessary for service agreement escrow accounting is to proceed directly from the service agreement sale to creating a new service agreement and it’s subsequent planned work orders. Failure to do so will result in the necessary journal entries not being created, and the escrow accounting portion of the service agreement setup not working.
Note: After selling any service agreement, a “Do the Paperwork” reminder will appear. This reminder refers to the “Services Agreements” dialog box usually displayed behind it. When selling an escrow accounting service agreement, it is critical to create a “New SA” and ignore the other choices.
Creating Escrow Accounting Service Agreements
After clicking the “New SA” button in the step above, the Edit Service Agreement window will appear. Review and confirm or adjust the displayed information brought forward from other related windows. Be sure to continue and create the planned work orders for the service agreement, which is covered below.
Creating Planned Work Orders
It is necessary to generate the planned maintenance visits before closing the “Add Service Agreement” window. The one and only opportunity for the necessary escrow accounting journal entries to be created is along with the planned work orders. If the “Add Service Agreement” window is closed even once without creating the planned work orders, the escrow accounting journal entries will never be generated, even if the form is re-opened at another time.
To create the planned work orders, use the menu button command Menu > Create > Planned Maintenance. The “Planned Maintenance” window will appear.
One noticeable difference in the “Planned Maintenance” window when escrow accounting is enabled, is the appearance of the “Escrow Amt.” column. The Escrow Amt. column displays the amount of prepaid cash which will be moved from the applicable escrow holding account and recognized as income on the date of each planned work order.
Note: When creating planned work orders for escrow accounting service agreements, the amount of prepaid funds to be recognized as income on each work order date is displayed in the “Escrow Amt.” column.
Create the planned work orders in normal fashion. The planned work order dates are proposed automatically and may be adjusted as necessary. These dates will subsequently be used for the escrow accounting journal entries automatically created as the work orders are generated. Refer to the related topic, “Service Agreements – Entering Existing Agreements”.
When the “OK” button is clicked, three important things take place:
- The planned work orders are created,
- The journal entry used to move the entire prepayment from income to the applicable escrow holding account is created, and
- The journal entries used to move portions of prepaid funds from that escrow holding account back to income are created.
A confirmation window will appear, reporting the successful creation of new work orders. You will then be returned to the “Add Service Agreement” window, where the “Completed” and “Not Completed” fields will display updated information based on the work orders just created. When finished reviewing and editing information, save & close the window.
IMPORTANT NOTE: The “Planned Maintenance” option on the service agreement is the only opportunity to create the journal entries required for escrow accounting. If this step is skipped, even with plans to return to the form later, the escrow accounting journal entries will not be created.
The Escrow Movement List
The Escrow Movement List is used to manage the escrow accounting journal entries. These are the necessary transactions which were automatically generated when the planned work orders were created.
If you change the date of an escrow movement, the date and other details of the work order will not be affected. Adjusting an escrow movement will not have any effect on its associated planned work order.
If you change the date of the Planned Work Order, the date of the escrow movement WILL be changed to match the work order.
How to Open the Escrow Movement Form
- From the main menu, click Customers | Service Agreement Escrow Movement.
Using the Escrow Movement Form
Perhaps the easiest way of using the commands available in this list is through its right click menu. The right click menu is identical to the title menu.
- To edit a transaction, right-click on it and choose Edit Transaction from the pop-up menu.
- To delete a transaction, right-click on it and choose Delete Transactions from the pop-up menu.
- To export whatever information is currently displayed in the list, right-click anywhere in the list and choose Export List from the pop-up menu.
Editing an Escrow Movement Transaction
From time to time it might be necessary to edit one of the escrow movement transactions. To edit a transaction, right-click on it and choose Edit Transaction from the pop-up menu. The Escrow Movement form will appear.
The editable fields are the Date field, Memo field, and Department field. A “Created/Revised By” stamp displays the identity of the original creator and the most recent reviser of the form.
Service Agreement Cancellation
If a customer cancels a service agreement prior to some or all of the planned work orders being performed, some or all associated work orders should be marked as “canceled” from the Work Order List, the Schedule Board, or within the work order itself. Then, depending on the circumstances, the dates of the corresponding escrow movements are manually edited from the Escrow Movement List.
Cancellation Before Any Work Orders Are Completed
For example, if a customer cancels a 2-visit service agreement before any work is performed,
- Both of the outstanding planned work orders should be marked as “canceled”.
- The dates on both of the outstanding escrow movements should be adjusted to the current date.
Edit the transaction date of outstanding escrow movements to the current date. This immediately moves those prepaid funds to income, thus available for use on a customer credit memo and subsequent refund check.
Issuing a Credit Memo or Refund Check
If needed, a credit memo and subsequent refund check can then be issued to the customer. The best way to create this credit is from the original service agreement sales form.
- Open the original sale then click Menu > Create > Credit.
- To issue a credit memo for a canceled service agreement, open the original service agreement sale and click Menu > Create > Credit.
- When the credit memo opens, it will already contain customer and item information based on the original sale. An internal memo is even automatically proposed.
- A credit which is created from an original sale or invoice, brings forward important information and also proposes an internal memo (circled in green).
- A refund check is produced from the credit memo by clicking Menu | Create | Refund Check.
Tip: Create a refund check from within a credit memo by clicking Menu | Create | Refund Check.
Cancellation After Some Work Orders Are Completed
For example, if a customer cancels a 2-visit service agreement after one work order has been completed,
- Only the outstanding planned work order should be marked as “canceled” (similar to above).
- Only the date on the outstanding escrow movement should be adjusted to the current date (similar to above).
- A credit memo and subsequent refund check can then be issued to the customer (similar to above). The major difference in this scenario is that the amount of the credit should be adjusted to half of the sales price because half of the work has been performed.
Although, the instructions above are for a simple 2-visit service agreement example, the concept extends to service agreements having many visits. Just cancel the outstanding work orders, adjust the dates of all outstanding escrow movements to the current date, and create a customer credit/refund for the amount of the outstanding planned maintenance visits.
- The “Planned Maintenance” option on the service agreement is the only opportunity to create the journal entries required for escrow accounting. If this step is skipped, even with plans to return to the form later, the escrow accounting journal entries will not be created.
Q: Can we manually do Escrow Accounting for past work orders and also have Escrow Accounting turned on for new service agreements?
A: Yes. You will need to enter Adjusting Journal Entries (AJE) manually for work orders created before turning on the Escrow Accounting feature.
Q: Will doing the above mess up our financial reports?
A: No. As long as you are entering your AJEs correctly. Be careful not to enter AJEs for Planned Work Orders that already have Escrow Movements. Note” The date on your AJEs will not change if you change the date of your work orders.