What are Passthrough Accounts and How do they Work?

Passthrough accounts are used to ensure firm Revenues are not inflated because of disbursements paid on behalf of clients.

Passthrough accounts are where income is journaled as a credit to the expense account when it is invoiced rather than to an income account. The purpose for this is so that income of the practice is not artificially inflated on the P&L.

Most of the time it is a disbursement account that is set up as the passthrough account.

Solicitor firms regularly pay disbursements on behalf of their clients. For example, if a firm bills $400,000 in fees and paid $600,000 in disbursements on behalf of clients then the sum of their invoices would equal to $1M. Whilst this in theory looks good, it is not quite accurate. For example, Professional Indemnity insurance is calculated based on billed fees, so the cost for insurance would be much less based on $400,000 as opposed to $1m. There are a number of other reasons that may be relevant to different firms, but you probably get the picture by now.

It is important to note that disbursement accounts will have to be specifically set up to be a passthrough account, if not, just left as standard then it will journal it to the disbursement income account. 

An example would be:

Not Using Passthrough

Income
Consultancy - $400,000
Disbursement Income - $600,000
Total Income - $1,000,000

Expense
General Expenses - $300,000
Disbursement Expense - $600,000
Total Expense - $900,000

Profit - $100,000

Using Passthrough

Income
Consultancy - $400,000
Total Income - $400,000

Expense
General Expenses - $300,000
Total Expense - $300,000

Profit - $100,000

As you can see from the example the profit is exactly the same.

It is also important to note that it is not retrospective, so once an invoice has been created, if you change the account to passthrough it won't have an impact on existing invoices.

Steps to set up a passthrough account:

1. Go to Chart of Accounts

2. Select the Disbursement Account

3. Click on edit account

4. The last field is called Account Type, click on the dropdown

5. Choose Pass Through

6. Click on Update