How to Record Reimbursement in Accounting

Recording a reimbursement seems straightforward, but getting it wrong can lead to inaccurate financial statements and tax headaches. Whether you’re paying an employee back for a business lunch or invoicing a client for a project expense, the accounting process needs to be precise. This guide will walk you through the correct journal entries for both employee and customer reimbursements, ensuring your books stay clean and compliant.

Understanding Why Proper Recording Matters

Before diving into the journal entries, it’s important to understand what’s at stake. Correctly recording reimbursements ensures:

• Accurate Financial Reporting: It prevents you from overstating revenue or expenses, giving you a true picture of your company's profitability.
• Tax Compliance: The IRS has specific rules for employee reimbursements. Following them determines whether the money is considered taxable income for the employee.
• Budget Control: Proper tracking helps you see where money is being spent, allowing for better budget management and cost control.
• Strong Client Relationships: For customer reimbursements, clear and accurate invoicing builds trust and avoids billing disputes.

There are two main types of reimbursement scenarios, and each requires a different accounting approach: reimbursing employees and billing customers for pass-through expenses.

How to Record Employee Reimbursements

When an employee uses their own money for a business-related expense, the company pays them back. How you record this transaction depends entirely on whether you have an "accountable plan" as defined by the IRS.

Under an Accountable Plan

For a reimbursement to be non-taxable to the employee, it must meet the three requirements of an IRS accountable plan:

1. There must be a clear business connection for the expense.
2. The employee must substantiate the expense with adequate records (like receipts) in a timely manner.
3. The employee must return any excess reimbursement or allowance within a reasonable time.

If your reimbursement policy meets these criteria, the payment is not considered wages and is not subject to payroll taxes. It's simply the company repaying a debt to the employee.

Here’s the step-by-step process for recording this transaction:

Step 1: The Employee Submits an Expense Report

An employee, Sarah, attended a conference and paid for her hotel room ($300) and client dinners ($150) with her personal credit card. She submits an expense report with receipts totaling $450. At this point, your company owes Sarah $450. You need to recognize this liability and the related expenses.

You’ll create a temporary liability account. You can call it "Reimbursements Payable," "Employee Reimbursements Due," or something similar.

The journal entry is:

• Debit Travel Expense for $300.
• Debit Meals & Entertainment Expense for $150.
• Credit Reimbursements Payable for $450.

Why this works: You've increased your expense accounts (a debit), which will accurately appear on your income statement. You’ve also increased your liability account (a credit), acknowledging the debt you owe to Sarah, which will appear on your balance sheet.

Step 2: The Company Reimburses the Employee

A few days later, you process the payment and cut Sarah a check or send a direct deposit for $450. This payment settles the liability.

The journal entry is:

• Debit Reimbursements Payable for $450.
• Credit Cash (or Bank Account) for $450.

Why this works: You've decreased the Reimbursements Payable account (a debit), bringing its balance back to zero because the debt is paid. You've also decreased your Cash account (a credit) to reflect the money leaving your bank.

Under a Non-Accountable Plan

If your reimbursement policy does not meet all three IRS requirements (for example, you give employees a flat $100 monthly allowance for gas without requiring receipts), it is a non-accountable plan. All payments made under this plan are considered supplemental wages.

This means the amount is:

• Included in the employee's gross income on their W-2.
• Subject to income tax withholding.
• Subject to payroll taxes (Social Security and Medicare).

In this case, you don't use a separate reimbursement entry. The payment is simply added to the employee's regular paycheck and processed through your payroll system. The journal entry would be part of your larger payroll entry, with the amount being debited to an expense account like "Wages and Salaries" or "Compensation Expense."

How to Record Customer Reimbursements (Reimbursed Expenses)

Sometimes, you purchase goods or services for a client with the understanding that they will pay you back. For example, a marketing agency might pay a freelance photographer’s fee for a client photoshoot. These are often called "pass-through" or "reimbursable" expenses.

The Common Mistake to Avoid

Many businesses incorrectly record the pass-through expense as a standard business expense (like Cost of Goods Sold) and then record the client's reimbursement as revenue. While the net effect on your profit seems to be zero, this inflates both your revenue and your expenses. This can distort your financial metrics and may even have tax implications, particularly for state-level gross receipts taxes.

The Correct Method: Using a Pass-Through Asset Account

The correct method treats the expense as an advance to your client. You are essentially holding a short-term receivable that has no bearing on your company's operational profit and loss. To do this, you'll need a dedicated "Other Current Asset" account on your chart of accounts. You can name it "Reimbursable Expenses," "Client Costs," or "Advances to Clients."

Here’s the step-by-step accounting process:

Step 1: You Pay an Expense on Behalf of the Client

Let's say your consulting firm pays a $1,000 court filing fee for a client. You are fronting this money and expect to be reimbursed. You use your company's bank account to pay the fee.

The journal entry is:

• Debit Reimbursable Expenses for $1,000.
• Credit Cash (or Bank Account) for $1,000.

Why this works: You've increased an asset account, Reimbursable Expenses, because the money is effectively a receivable—it's value you expect to recover. This correctly keeps the $1,000 off your income statement for now. You've also shown the cash leaving your bank.

Step 2: You Invoice the Client for a Service and the Reimbursed Expense

You're ready to bill the client for your consulting services, which came to $5,000. You'll add the $1,000 filing fee as a separate line item on the same invoice, for a total invoice amount of $6,000.

The journal entry to create the invoice is:

• Debit Accounts Receivable for $6,000.
• Credit Service Revenue for $5,000.
• Credit Reimbursable Expenses for $1,000.

Why this works: You've created an invoice for the total amount due ($6,000) by debiting Accounts Receivable. You’ve recognized the $5,000 you actually earned as revenue. Finally, you’ve credited the Reimbursable Expenses asset account, which zeroes out the balance created in Step 1. Your books now correctly show you're owed the money as part of a general receivable rather than a specific advance.

Step 3: The Client Pays the Invoice

The client pays your $6,000 invoice in full.

The final journal entry is:

• Debit Cash (or Bank Account) for $6,000.
• Credit Accounts Receivable for $6,000.

Why this works: You’ve increased your cash balance and cleared the accounts receivable for this client. The entire cycle is complete, with only your actual revenue and the corresponding cash receipt affecting your core financial statements.

Using Accounting Software to Simplify Reimbursements

Most modern accounting platforms have features to make this process easier.

• QuickBooks Online: The "billable expense" feature in QuickBooks Online Plus automates the flow for customer reimbursements. When you enter a bill or a check, you can mark an expense as "Billable" and assign it to a customer. When you later create an invoice for that customer, QuickBooks automatically prompts you to add the reimbursable expense.
• Xero: Similarly, Xero allows you to assign expenses to a customer and pull them onto a new invoice. This feature functions similarly to the QuickBooks "billable expense" and keeps the amount from hitting your own expense accounts. You can also manually use the process described above.
• Wave: In free tools like Wave, you can replicate the manual process by creating a "Reimbursable Expenses" asset account. Just follow the journal entry steps outlined above to ensure your books remain accurate.

Final Thoughts

Recording reimbursements correctly boils down to differentiating between money spent as a business operation versus money spent as an advance to an employee or client. By using a payable account for employees under an accountable plan and a pass-through asset account for clients, you ensure your financial reports are accurate and your business stays compliant.

When dealing with the nuances of accountable plans, multi-state travel rules, or the tax treatment of certain expense categories, precise information is key. This is where having immediate access to authoritative sources makes a difference. With Feather AI, you can get instant, citation-backed answers to complex tax questions, helping you design and maintain reimbursement policies that are fully compliant with IRS and state regulations.