Free Services as an expense

I have to track a service provided at no charge as an expense. It is considered an advertising and promotion expense. The service is identical to one I do regularly and charge for, but occasionally it is done at no charge.
I do not want to inflate the sales invoice by entering this as income, but do want to to be recorded as an expense.

I created a sales invoice item for this service and used the account for advertising and promotion expenses.paid for service. This created two problems. It erroneously inflated the sales income and showed in the advertising and promotion account as a debit (have I got the use of that term right?) and therefore was deducted from the total of expenses in the account. (There are some others entered as Purchase Invoices or directly as Spent Money from the banking accounts).

I reset the price for the freely provided service to zero so that the sales invoice doesn’t inflate revenue. But it isn’t increasing the total in the expense account either.

Have considered using some sort of Journal Entry to track this, but while I know which account I want the expense to be in I have no idea what account to take the money from, and in fact there isn’t any revenue really to offset the expense with so the journal transactions would always be out of balance.

Anybody got a suggestion

Would I be able to use a journal entry from the Retained Earnings to the Advertising and Promotion accounts?

You raise a very interesting subject, @Ron_Thibault.

It may help to consider the fact that, in the situation you described, there is no real expense. When you spend money from a bank account to purchase something, the appropriate expense account is debited and the bank account is credited. But when you provide a free service, there is no account to credit; since debits and credits must match in every transaction, you can’t debit anything.

I can understand your desire to track the value of services you are giving away for promotional purposes. But a service given away isn’t an actual expense like giving away inventory would be. The inventory has an acquisition cost and could presumably be sold to some other customer for a price similar to other sales. Giving away inventory reduces the value of a current asset and must be offset on the books, which debiting a promotional services expense account would do. The same is not true for services.

The fact that other customers may pay you for the service in different circumstances does not mean it has value to the customer involved. Giving it away does not reduce your ability to perform the service for others. Ironically, the fact that you are giving it away may stand as proof that the service has no value in the particular market segment and under the exact circumstances where it is being delivered. It is an inducement to a customer to purchase a product or service, now or in the future. If it’s an inducement for a current purchase, you might think of it simply as a price reduction or discount. If it’s an inducement for future purchases, it really is just an expression of personal good will to a potential customer.

Promotional offsets or discounts can be included in your accounting when sales invoices are issued. The principle to recognize, however, is that the way you handle them must not distort your true net income. So if you want them going into a promotional expense account, their value must first go into an income account. One way to do this is to include the fair value of the service on your sales invoice, but also include a negative amount or discount allocated to a promotional expense account. Because line items on sales invoices are normally credits (usually to income accounts), a negative figure allocated to an expense account will turn into a debit, which is what you want to make the promotional expense account increase. The reported income will go up, but so will reported expenses, and by the same amount. Net income remains unchanged.

But what do you do if a sales invoice won’t be issued? I think most accountants would argue that since there is no expectation of revenue being received, no income should be recognized. One of the usual requirements for recognition of income is that its value be determinable with reasonable certainty. As mentioned above, you have established that this particular service for this particular customer at this particular time has no value. Therefore, you have done nothing to earn income. Another major accounting principle is that expenses should be recorded to match the period during which the income they are related to is recognized (at least for accrual accounting).

And, of course, you can’t just arbitrarily enter expenses when you haven’t spent money. That’s the path to prison.

In summary, if you invoice for the service, you can immediately discount it, with no impact on net income, but a record of its value will be kept. If there is nothing else on the invoice, you wouldn’t even have to give it to the customer, as no account receivable will be created. One slight variation on this approach is to invoice the customer for the service, never deliver the invoice, then write off the account receivable in a manner similar to bad debts. On the other hand, if you are not going to recognize earned income, you can’t record the expense.

Sorry to be so long-winded. But before I quit, let me say you could also just discount the service on the invoice. But that just lowers its price to zero and gives up any ability to track what you’ve done.

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Thank you, Tut, for a carefully considered and thorough response. I will think on this all a bit more before deciding how to proceed. Certainly not going to do jail time for a few bucks.

Obviously, a little hyperbole there! But penalties, fines, etc. are definite possibilities.

The standard practice here e.g. Legal firms who do Pro Bono work, is to create an income account like “Service Fees Forgone” and a corresponding expenses account like “Promotional Service Fees”. Then by creating a Sales invoice, which will attach the activity to a Customer you could use your existing Sales Invoice Item (with changed chart of account) for the service value, then on the next line you deduct the same value (by using a minus sign in front) to the expense account - a zero invoice.

If you don’t want these values to inflate your actual P&L income/expense, you could create a P&L group after Expenses and allocate both accounts to there as they will contra themselves out .

I run a pest control company. We have a annual promotion day with the Golf club which is a not for profit business.
I buy certain items which I Allocate to expense promotions, but I also print vouchers for say $50.00 each, which the winners etc. can use for my pest control services. Can I also put these in as a promotional expense, and if so how is it done.

When the Gift Voucher is given out to the winners you have two choices

  1. do nothing until the actual service is provided.
  2. record the Gift Vouchers as credits against either a liability account, a promotional customer account or if the winner is an existing customer against their account.

You would only use (2) if there is certainty that the Gift Voucher will be used in the near future.

For (1) - when the service is completed do a normal Sales Invoice or Receive Money (cash sale). Enter the full value of the service as income and add a line - Account = Promotion Expenses with a -50.00 (note minus) which will either leave a zero or outstanding balance.

For (2) - create credit notes for the Gift Vouchers if using the Customer accounts and use account Promotional Expenses. These would act as prepayments against future Invoices

Or use a Journal if putting the Gift Vouchers to a liability account - Debit Promotional Expenses and Credit Liability account (Gift Vouchers Unclaimed). Then when the service is Invoiced put the -50.00 against the liability account - any balance reflects unclaimed services

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I would really consider the @Brucanna answer. This transactions may be done in different ways. In sales, credits are applied different than services, or exchange of services. In your case, it seems like you’re doing some “pro-bono” work or something like that, so you have to create an income and an expense. There is no other way you should do this. You have to create an income because you’re doing a service and for every service you should be invoicing. You can’t create a transaction with just a debit; in every transaction there’s a debit and there’s a credit. In this case, your debit is to advertising expenses. And the credit? You can’t create a liability, you can’t assign a credit to other expense account, so you’ll have to create an income. The expense you’re creating is a contra-account for the income, so in the end your result will be zero anyways, but if you want to record this you have to create the income and the expense. In other words, if you have to present your books to a Governmental Entity at some point, if you don’t create the income for this transaction they’ll see that there is an advertising expense that comes from nowhere, so there is one risk. I would recommend, like @Brucanna said, creating an income and an advertising expense account in a group after expenses in the P&L just for this kind of use, so you can track it better; these two accounts should always have the same total amount.

Just use your normal P&L Income & Expense accounts - there is no need to create extra group or accounts just for a few entries.

Hi @Brucanna and @sulfuror, thank you very much for your help. @Brucanna, I will take your advice, and as in 1. will do nothing until the actual service is provided, then issue a Sales invoice with another line as a -50 to promotional expenses.

Contrary to most responses here, which suggest creating a separate account, I think such an expenses shouldn’t be recorded at al. Here is why.

For any invoice that you issue for a customer, you are expecting an income. That is not an expense. The expense is already recorded in the form of salaries, items purchased etc.

If you had no income and did everything for free, your expenses were still being recorded immaterial to the fact that you have no income.

In the current scenario too, even if you offered a free service, you must have already booked your expenses in the form of salaries, rent or items purchased. Booking a separate expenses for free service is double counting the same expense.

About recording the magnitude of such services, I normally account it as a 100% discount on the total invoice value. An invoice can always have a 0 sale value.

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Thank you for your response. As @Brucanna stated, when I issue the vouchers for $50.00, I do nothing until the winner then uses the voucher. I then invoice the winner for say $150.00 for the job, but add a line of in this case a -$50.00 posting to promotions. I guess it could just as easily be posted to discount given on sales. This will show income of $150.00, and expenses of $50.00. Is that correct

50 is not an expense. It’s a discount.

Expense is in the form of the cost of the material (fuel in your case).

The way you handle this currently, it is fine. You are giving a discount effectively. The only difference of opinion here is that this 50 is not an expense.

Thank you for your reply. So are you saying when I issue an invoice say for $150.00 for pest control services that is posted to PC income, but if I give a $50.00 discount, that will not be posted to discount as an expense, but must be posted to discount as a minus income?

If you re-read the statement “We have a annual promotion day with the Golf club”. A promotion day is a marketing expense. The gift vouchers being offered as prizes, impose a future cost on the business - a reduction in income. It very appropriate to track such activities in specific accounts so the business can access the impacts.

If the business offered 50,00 worth of products as prizes instead of the 50 gift vouchers, would those products be classified as discounts - no, the inventory would be written off to a marketing account. EG: a soft drink manufacturer providing free drinks as sponsorship to a sporting club - no discount here as there is no sale

Expenses don’t have to be actual payments. Depreciation is recorded as an expense and there is no payments involved there. Same with Amortisation. Bad Debts are an expense because the customer failed to pay, no payments involved here and it certainly not a discount.

No its not as you can never double count any expense. If there is only one free service then there is only one expense. What you are ignoring is the fact that the free service is initially taken up as income and then is subsequently expensed/discounted - a natural double entry.

If the 50 reduction is shown as an expense or a discount is entirely a management decision, just as its their choice as to where their Discount Allowed account is placed, as either:

  1. a component of the P&L Income group
  2. a component of the P&L COS (COGS) group
  3. a component of the P&L Expenses group.

Freedom of choice, no must involved. How you want to understand the transaction in your financial reports is your call. As an expense of the promotion day which was the reason for the Gift Vouchers, as a discount which can be shown as either negative income or expense account.

Sorry Brucanna, I do not agree with you on this here.

Let’s take an example to draw the point home. Let me be in a business of selling a Product at price 10. My raw material cost for one item is 5. I make and sell 10,000 of these products on a monthly basis and draw a salary of 30,000. In this case,

Revenue = 100,000

COGS = 50,000
Expense = 30,000

Net profit = 20,000

Now, let’s say we offered 1000 items for free (or for some promotion or as gift voucher). If I consider these as expenses, the result will be

Revenue = 100,000-10,000

Marketing Expense = 10,000
COGS = 50,000
Expense = 30,000

Net Profit = 0.

There is something wrong here. Your actual expenses still remain the same at 50,000 + 30,000 = 80,000. Also, your revenue reduced only by 10,000. So, how can the net profit be 0?

Here is how it should be handled correctly as discount (or promotion - pick a name)

Revenue = 100,000
LESS Discount = 10,000
Net Revenue = 90,000

COGS = 50,000
Expense = 30,000

Net profit = 10,000

Now, I agree that this discount needs to be tracked against marketing. This is a discount because this was a potential earning for you which you gave away for some other gains.

The tracking could be done through accounting codes.

There is another reason why it shouldn’t be considered as an expense. If there is a new business which gives 1000 items of 10 each for free to everyone, should they consider it as a sale of 10,000 and expense of 10,000?

That’s not right because that way everyone will start inflating their P&L without any actual revenue.

Why is your revenue reduced - 10,000 sold @ 10 = 100,000, 9,000 sold @ 10 = 90,000 + 1,000 free @ 10 = 10,000 - therefore the total = 100,000 so there is no revenue loss

The problem with your model is this:

  1. you are mixing up products and gift vouchers (apples & oranges)
    Products have a cost (5.00), gift vouchers have no cost.
    Therefore with gift vouchers you take up an income to established the cost of the gift vouchers.
    With products there is no income to take up as there is an actual product cost to expense.
    It doesn’t matter if the product is given away or has fallen off a truck - there is no sale so no revenue.

  2. plus the accounting is incorrect
    negative income (-10,000) is a debit, marketing expense (10,000) is a debit - impossible Journal
    If you sold 10,000 then sales = 100,000, if you sold 9,000 then sales = 90,000
    If you sold 10,000 then COGS = 50,000, if you sold 9,000 then COGS = 45,000
    In both cases Salary expense = 30,000
    Therefore at this point the profits are 20,000 and 15,000 + 5,000 (1,000 @ 5) still in inventory
    You give the remaining 1,000 away then the inventory 5,000 becomes marketing 5,000
    Now the profits are 20,000 and 10,000 and the 10,000 differential is represented by the revenue forgone by not selling them (1,000 @ 10) or (100,000 v’s 90,000)

Now lets say you wanted to show the forgone revenue as sales in the accounts, then the Invoice would be: credit income 10,000, credit inventory 5,000, debit COGS 5,000 and debit marketing 10,000 - the profit remains at 10,000

Inflating their P&L how ? if you have 10,000 income and 10,000 expenses which shows the actual business activity (giving away freebies) and resulting in a zero profit - then what’s being inflated. If you ignored the 10,000 income and 10,000 expenses then that would indicate that the business has had zero activity - which isn’t correct, it gave away freebies