The difficult economic climate of recent years has led more businesses to use barter transactions, in which they trade their products and services for products and services from other businesses. Many business owners wrongly assume they don’t need to account for these barter transactions. But it’s required by the IRS and is essential to accurately determining the financial health of your business.
When you barter for other goods and services, you’re still investing time and resources to sell the item you’re trading. You’re simply receiving a commodity other than cash in exchange for your product or service. Not accounting for barter transactions is the same as not accounting for revenue and expenses: a sloppy no-no. This means you can’t generate accurate financial statements, which in turn means it’s impossible to determine how well your business is doing.
Recording barter transactions is pretty simple if you break them down into individual pieces. When you barter, two transactions occur: 1) you sell something and 2) you buy something. The most confusing factor can be determining the value of the transaction. IRS guidelines dictate that you must value the transaction at the fair market value of the item you are receiving. In most cases, the fair market value is already known—it’s the normal sale price of the item. The sale of your goods or services is valued at the purchase price of the goods you’re receiving. In effect, their values should be equivalent.
Of course, you have to record the receipt of the item. If the item you received is a valid business expense, you record it just as you would if you had paid cash. Instead of cash, you paid with your goods or services. If the item you received is for your personal use, you record it as if you took cash out of your business (draw, payroll advance, and so on).
How this works
Let’s look at some examples to see how it works in practice:
Let’s say you barter with your local computer guru for a portable hard drive. The fair market value for the drive is $100. The good or service you provide in exchange—say a vintage framed poster—must be valued at the same rate: $100.
Here’s another example: A designer trades some website design services for two months of free rent. Rent is normally $800 per month. The designer would record the transaction at $1,600, the value of two months rent. Because the rent is a business expense, the designer would debit “Rent Expense” for $1,600 and credit “Income” for $1,600.
What else ya got?
What if you want to barter one of your goods or services, but none of your business buddies have something you want or need? The answer lies with something known as “barter exchanges,” which are becoming common these days. When you trade through a barter exchange, you trade for “points” through a third-party organization. You accumulate points by selling your goods and services to other members of the organization and apply those points when you find something you want to buy.
If you trade through a barter exchange service, it’s important to understand that barter income is cash basis. When someone “buys” your services with trade credits or points, you generate reportable income. The fact that you haven’t spent your trade credit isn’t relevant. When you do spend your trade credit, you record the expense just as you would with a direct trade (as a normal business expense or personal draw).
The easiest way to account for barter exchanges is to set up a “bank” account on your books called “Barter Exchanges.” When you sell something through an exchange, make a deposit into the “Barter Exchanges” bank account, crediting “Income.” When you purchase something from the exchange, you can simply “write a check,” debiting the appropriate expense account. Using this method, you have a complete record of all transactions running through your barter account and you’ve properly recorded your income and expense. You can also make reconciling your barter account a part of your normal monthly close process.
The nitty gritty
Properly accounting for both types of bartering—direct or through an exchange—is essential to accurately representing your revenue and expenses. When recording direct barter transactions, you’re essentially recording a sale and a purchase. Instead of recording two transactions—one in which you sold something for cash and one in which you purchased something with cash—you record one transaction and skip the cash. Barter exchange transactions are similar to cash transactions; you just need a barter bank account to record them. Remember to keep a paper trail for both barter transactions and barter exchanges and note them as barters. For more information, see the IRS document “Record Keeping for Barter Transactions.”