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A clearing account acts as a temporary account that holds transactions before they are finalized or allocated to the correct permanent account. Sometimes called a “wash account,” this intermediary account is essential for businesses to ensure accurate and organized financial record-keeping. Accounting often uses clearing accounts for reconciliation, transaction tracking, or other accounting processes.
A clearing account is distinctly different than a suspense account, which also holds funds temporarily. Suspense accounts are only used to hold funds in cases where a transaction appears to have a problem requiring further research.
A clearing account is primarily used as a holding space for funds or transactions. The money or transactions sit in this account until they can be classified appropriately and moved to their respective permanent accounts. Clearing accounts are particularly useful for complex transactions that require time to sort out the details.
These accounts allow companies to simplify bookkeeping, especially when multiple transactions occur quickly, like when sales tax is collected or during payroll processing. Segregating transactions by type and consolidating them into one account before they get sent to the final destination is much simpler than sorting through transactions one by one.
How does a clearing account work?
A clearing account is a general ledger that allows accountants to maintain transaction details temporarily. Its purpose is to record income (or expenses) before they are moved to the balance sheet as retained earnings.
Clearing accounts can be set up to clear daily, monthly, or at the end of the fiscal year. Clearing happens via ACH technology, automatically transferring the funds to another count, rendering the balance zero.
The final zero balance allows accounting to know that bookkeeping happened correctly. A zero balance means accounting can record the information in the main ledger error-free.
What does a clearing account look like in action?
Let’s say Cool Pic Inc. sells artistic photography and must collect a 10% sales tax on all sales. Cool Pic could set up a clearing account specifically for sales tax to make accounting easier while streamlining sales tax remittance to tax authorities.
Cool Pic might sell a large photography print for $500 plus the 10% sales tax. The total amount the customer pays is $550 ($1,000 for the print and $50 for the sales tax). Accounting then records the sales transactions accordingly:
- Debit: Cash (or Accounts Receivable) $550
- Credit: Sales Revenue $500
- Credit: Sales Tax Clearing Account $50
At the month-end close, Cool Pic calculates the total sales tax collected by summing up the balances in the sales tax clearing account. For example, if the total sales tax Cool Pic collects for the month is $1,000, it will remit that amount to the tax authorities. Accounting will record the following in the journal:
- Debit: Sales Tax Clearing Account $1,000
- Credit: Cash (or Bank Account) $1,000
This brings the balance in the sales tax clearing account to zero, which reflects that the total amount of sales tax collected has been remitted.
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