How do suspense accounts work?
A very important question for anyone working in accounting or auditing,
or studying these fields.
In this video, we look at various aspects of suspense accounts:
First, suspense accounts as temporary "waiting accounts" for unclassified transactions.
Second, suspense accounts as "plug" accounts to balance the trial balance.
These first two roles of suspense accounts are often perceived a potential control risk,
so we will review indicators of suspense accounts posing a control risk, and discuss how to
recognize suspense accounts.
The third section of this video takes a more positive view: using suspense accounts as
a proactive control procedure.
To understand the concept of suspense accounts, it is important to know that the word "suspense"
comes from the verb "to suspend", which has various meanings.
The most appropriate in relation to suspense accounts is: temporarily prevent from continuing
or being in force or effect, and more specifically: defer or delay an action, event or judgement.
Use of a suspense account allows a person making a journal entry to temporarily postpone
his or her judgment about where an amount really belongs in the chart of accounts.
Let's assume you are a junior accountant that is tasked with booking journal entries related
to movements on the bank account.
You have four items to record.
One of these items in the example will include use of a suspense account.
Item number one is related to telephone usage, as the vendor name Vodafone suggests.
In the bank statement detail, you find the invoice number, so if needed you could retrieve
line item details from that invoice to split the telephone costs over various costcenters.
The entry is straightforward: credit the cash account, and debit telephone expenses.
Please note that different countries have different habits of using decimal points or
commas, the amount here is 40 Euro and 67 cents.
Item number two is related to travel expenses, as the vendor name Brussels Airlines suggests.
The entry is: credit the cash account, and debit travel expenses.
Item number three is a bit more complicated, as this seems to have been an online purchase
going through a payment provider called GlobalCollect.
In the bank statement detail, you find that this item is for a KLM flight, and we even
find a booking code for the flight.
Just like in the previous entry, you credit the cash account, and debit travel expenses.
Item number four has also gone through the payment provider called GlobalCollect.
In the bank statement detail, you find that this item is for Dell Products.
As Dell sells a wide range of products and services, you would like to find out what
specifically was bought here.
The person in your company who is in charge of buying computer equipment is not in the
office today, so in order to finish your cash journal entries you temporarily book this
amount to a suspense account, and when on the next day you hear that a power supply
for a laptop was bought, you reclass the amount from suspense to office supplies.
That's the first use of suspense accounts: you park an "unclassified transaction" there,
which should be temporary only, as you work to reclass the amount to the correct account
as soon as possible.
As any corporate controller or accounting textbook will tell you: the best balance for
a suspense account is zero, with no open items!
Suspense accounts are an unfortunate but necessary part of any general ledger system.
To understand the second type of use of suspense accounts, you need to understand a little
bit about the history of accounting.
Luca Pacioli is often called the "father of accounting" because he was, in 1494, the first
to publish a detailed description of the double-entry system, thus enabling others to study and use it.
From those Renaissance days to the 1970s, manual bookkeeping, by hand, recording entries
in ledger books, was the way to go!
You would have separate accounting teams working on various subledger books, such as payroll,
cash, inventory, receivables, and many others depending on the type of company you were working for.
From each of these subledger books, summary amounts would be transferred into a central
place called the general ledger.
As you can imagine, due to the manual nature of the process, this process is prone to errors
like transposition errors like writing 51 instead of 15, or accidentally posting a single
entry rather than a double entry.
The control mechanism that was put in place is called a trial balance.
A trial balance is a list of all the general ledger accounts contained in the ledger of a business.
This list will contain the name of each nominal ledger account and the value of that nominal ledger balance.
Each nominal ledger account will hold either a debit balance or a credit balance.
The debit balance values will be listed in the debit column of the trial balance and
the credit value balance will be listed in the credit column.
If the total of the debit column does not equal the total value of the credit column
then this would show that there is an error in the nominal ledger accounts.
In this example, our debits on the left are bigger than our credits on the right.
This is where a suspense account comes in: you "plug" the missing amount (a credit amount of 3)
in the suspense account, in order to artificially and temporarily balance the trial balance.
You then start the error review and correction process.
This error (or multiple errors) causing the imbalance must be found before a profit and
loss statement and balance sheet can be produced.
We have moved from the days of manually writing our journal entries into large ledger books,
to electronic posting of journal entries into large databases.
Every accounting system that I have ever used has a validation rule that checks whether
a journal entry is balanced, so the need to check whether a trial balance is balancing
between debits and credits has decreased.
It's still worthwhile to know how suspense accounts work in the days of electronic postings,
as somebody could have "forced" a journal entry to go through by plugging amounts into suspense.
When is a suspense account a control risk?
First of all, if the suspense account is used frequently.
Do you have the right datafeeds to correctly classify entries?
Do you have properly qualified people making the entries?
If journal entry amounts are high.
If there is complicated account activity, which is hard to follow.
If items stay unresolved for a long time.
This could indicate insufficient staffing levels, or insufficient focus.
If the balance of the suspense account is not zero at the end of the reporting period.
If no formal procedure is in place to resolve open items.
Incorrect use of suspense accounts could lead to material accounting misstatements.
If there is a large debit on a suspense account rolling up into the balance sheet,
then expenses could be understated.
Incorrect use of suspense accounts can also be a sign of fraud!
For both of these reasons, controllers and auditors should be on top of this topic!
How to recognize a suspense account?
In most cases, the word "suspense" is in the account name.
However, there could be multiple accounts with the word "suspense" in there, so review
the whole chart of accounts for completeness!
Furthermore, an account could function as a suspense account but be named differently:
undistributed debits or undistributed credits for example.
The last section of this video is about turning the concept of suspense accounts around, and
proactively using it as a control mechanism.
Let's say that you have historically processed incoming payments from customers using method A.
You receive a bank statement, book the cash receipt by customer in the general ledger
by debiting cash and crediting accounts receivable.
You have the same person close the open invoice in the receivables subledger, and periodically
but infrequently reconcile the receivables amount in the subledger to the amount in the
receivables general ledger account.
An alternative method, using a suspense account to your benefit, would be method B. You receive
a bank statement, have employee #1 book the cash receipt by customer in the general ledger,
by debiting cash and crediting the payment suspense account.
A different person, employee #2, closes the open invoice for this customer in the receivables
subledger, and this system feeds this data into the general ledger by debiting the payment
suspense account and crediting receivables.
If all goes well, the payment suspense account has a balance of zero at the end of the day.
If any mistake is made, you have your employees and possibly their manager reconcile the entries
until they have found and corrected the error.
With today's accounting systems, you could use subledger codes to simplify this process.
This method incorporates the four-eyes principle or two person rule which means that certain
activities must be approved or recorded by at least two people.
In this video, we have looked at various aspects of suspense accounts:
Suspense accounts as temporary "waiting accounts" for unclassified transactions.
Suspense accounts as "plug" accounts to balance the trial balance.
Suspense accounts as a control risk.
And using suspense accounts as a proactive control procedure.
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