A Complete Guide To Clearing Accounts With Examples, Types, and Benefits

Introduction

Understanding how money moves and is managed effectively is crucial in the world of finance. One essential tool that facilitates this process is the clearing account. A clearing account is a special account used in accounting and finance to temporarily hold transactions until they are properly allocated to their destination accounts. 

Unlike suspense accounts, which hold transactions that are unclear or uncertain, clearing accounts are used for transactions that are in transition but clearly identified.

In this blog, you’ll explore the clearing accounts definition, its main purposes, and how it works. By the end, you’ll have a clear understanding of why clearing accounts are vital in financial management.

What Is A Clearing Account?

A clearing account is a general ledger account that temporarily holds transactions until they can be permanently recorded in the appropriate account. It serves as a tool to ensure that transactions are accurately matched and reconciled before being finalized in the financial records.

For example, consider a company’s payroll process. When payroll is processed, the total amount might be temporarily held in a payroll clearing account. Once all individual employee payments are confirmed and matched with their respective payroll expense accounts, the amounts are then moved out of the clearing account to the appropriate accounts.

In the next section, we’ll explore the main purposes of clearing accounts and why they are essential for effective financial management.

The Main Purpose of Clearing Accounts

Clearing accounts play a crucial role in maintaining the accuracy of financial records by ensuring that all transactions are properly categorized and reconciled. This helps businesses streamline their transaction processing, avoid discrepancies, and maintain precise financial reporting. Here are the main reasons why businesses use clearing accounts:

1. Facilitates transaction reconciliation

Clearing accounts are primarily used to reconcile transactions before they are posted to their final accounts. This process ensures that all transactions are accurately matched and discrepancies are identified and corrected. For instance, payments received from customers can be held in a clearing account until they are matched with the corresponding invoices. This helps in maintaining the accuracy of financial records.

2. Acts as a temporary holding account

Clearing accounts act as temporary holding places for transactions that are in transit. This is particularly useful for transactions that occur over a period, such as payroll processing or large purchases requiring multiple steps. By temporarily holding these transactions, clearing accounts provide a buffer that allows businesses to complete all necessary steps before finalizing the entries in the general ledger.

3. Improves cash flow management

Effective cash flow management is critical for every business. Clearing accounts help manage cash flow by providing a clear picture of pending transactions. For example, when a company processes multiple customer payments, these funds can be held in a clearing account until they are allocated to the appropriate accounts. This helps businesses manage their liquidity more effectively.

4. Effortless error detection and correction

By using clearing accounts, businesses can easily detect and correct errors before they are permanently recorded in the financial statements. This is crucial for maintaining the integrity of financial data. If a discrepancy is found during the reconciliation process, it can be addressed in the clearing account without affecting the main ledger accounts.

5. Helps streamline complex transactions

Clearing accounts simplify the handling of complex transactions that involve multiple steps or parties. For example, in e-commerce businesses, payments from customers might pass through several intermediaries before reaching their final destination. A clearing account can be used to manage these intermediary steps, ensuring that each part of the transaction is accurately processed.

Clearing accounts play a vital role in ensuring the accuracy and efficiency of financial transactions. They help businesses reconcile transactions, manage cash flow, detect errors, and streamline complex processes. This, in turn, contributes to overall financial stability and transparency. 

How Does Clearing Accounts Work ?

Clearing accounts operate by temporarily holding transactions until they can be appropriately categorized and finalized in the company’s financial records. Here’s a step-by-step breakdown of how clearing accounts work:

Step 1 – Initiation of Transactions

• When a transaction is initiated, it is first recorded in a clearing account.
• This applies to various transactions, such as customer payments, payroll, or internal transfers.

Step 2 – Temporary Holding

• The transaction remains in the clearing account as a temporary entry.
• Necessary checks and verifications are performed during this period.

Step 3 – Reconciliation Process

• The transaction in the clearing account is compared against corresponding records to ensure accuracy.
• For example, a payment from a customer is matched with the related invoice.
• Discrepancies, if any, are resolved during this phase.

Step 4- Allocation to Final Accounts

• Once verified and reconciled, the transaction is moved from the clearing account to its final destination account.

Examples include:

1. Customer payments: Moved from the clearing account to the final payment account.
2. Payroll: Transferred from the payroll clearing account to individual employee accounts and corresponding expense accounts.
3. Purchases: From the clearing account to inventory or expense accounts.

Step 5 – Error Correction

• If discrepancies are identified, they are addressed before the transaction leaves the clearing account.
• This ensures that only accurate transactions are recorded in the final accounts.

Step 6: Reporting and Review

• Regular review and reporting of clearing account transactions help monitor the status of pending transactions.
• Businesses can generate reports to track entries, identify outstanding items, and ensure timely resolution of issues.

Example of Clearing Account

To illustrate how a clearing account works, let’s take an example of a company that receives payment of $2000 from the customer. Prior to allocating it to the appropriate account, this payment is recorded in a clearing account.

Initiation of Transactions

A company receives a payment of $2000 from the customer for goods sold on credit. 

Transactions:

Recording in the clearing account 

On receiving the payment, as it is yet to be reconciled, the amount is held in a clearing account. This translates to a debit (increase) in the account receivables clearing account and a subsequent credit (decrease) in accounts receivables as the outstanding amount has been received from the customer.

Allocation to the final account

Once the payment is reconciled and matched against the invoice, it is then allocated to the appropriate account.

As the payment has been matched with the corresponding invoice, the payment is moved to the company’s cash account. Hence, the account receivables clearing account is credited and the cash account is debited. 

5 Types of Clearing Accounts

Clearing accounts come in various forms, each serving a specific purpose in financial management. Here are some common types of clearing accounts and their functions:

1. Payroll clearing account

Purpose: Used to temporarily hold payroll funds until they are distributed to employees.

Function: When payroll is processed, the total payroll amount is transferred to the payroll clearing account. As individual employee payments are made, the corresponding amounts are deducted from the clearing account.

Example:

• Initial Payroll Transfer:
• Debit: Payroll Clearing Account $50,000
• Credit: Bank Account $50,000
• Employee Payment:
• Debit: Employee Salary Expense $3,000
• Credit: Payroll Clearing Account $3,000

2. Cash clearing account

Purpose: Used to manage and reconcile cash transactions that are pending final allocation.

Function: Helps businesses track cash inflows and outflows until they are properly recorded in the respective accounts, ensuring accurate cash flow management.

Example:

• Customer Payment Received:
• Debit: Cash Clearing Account $2,000
• Credit: Accounts Receivable $2,000
• Final Allocation to Bank:
• Debit: Bank Account $2,000
• Credit: Cash Clearing Account $2,000

3. Inventory clearing account

Purpose: Used to temporarily hold inventory costs until the items are received and verified.

Function: Ensures that inventory purchases are accurately recorded and matched with invoices and receipts.

Example:

• Purchase Order Issued:
• Debit: Inventory Clearing Account $10,000
• Credit: Accounts Payable $10,000
• Inventory Received:
• Debit: Inventory $10,000
• Credit: Inventory Clearing Account $10,000

4. Sales tax clearing account

Purpose: Used to collect and manage sales tax from sales transactions until it is remitted to tax authorities.

Function: Helps in tracking the amount of sales tax collected and ensuring timely and accurate remittance.

Example:

• Sales Transaction:
• Debit: Cash (or Accounts Receivable) $550
• Credit: Sales Revenue $500
• Credit: Sales Tax Clearing Account $50
• Tax Remittance:
• Debit: Sales Tax Clearing Account $1,000
• Credit: Cash (or Bank Account) $1,000

5. Fixed asset clearing account

Purpose: Used to temporarily hold costs related to acquiring fixed assets until the asset is ready for use.

Function: Helps in tracking the costs associated with acquiring and preparing fixed assets for operational use.

Example:

• Asset Purchase:
• Debit: Fixed Asset Clearing Account $20,000
• Credit: Accounts Payable $20,000
• Asset Ready for Use:
• Debit: Fixed Assets $20,000
• Credit: Fixed Asset Clearing Account $20,000

Each type of clearing account serves a specific role in ensuring that transactions are accurately recorded and reconciled. By using clearing accounts, businesses can manage complex financial processes more efficiently and maintain precise financial records.

How HighRadius Can Ensure Error-Free General Ledger Reconciliation 

Maintaining an accurate general ledger is critical for any business, as it forms the foundation of all financial reporting. One of the key challenges in this process is reconciliation, especially when dealing with clearing accounts. While reconciliation ensures that all transactions are correctly matched and recorded, it can be time-consuming and prone to errors. This is where HighRadius can make a significant difference.

HighRadius offers a comprehensive Record to Report solution that automates the Account Reconciliation process, reducing manual effort and minimizing the risk of errors. By leveraging advanced algorithms and AI/ML-enabled Transaction Matching,, HighRadius ensures that transactions in clearing accounts are accurately reconciled and posted to the general ledger. This helps organizations achieve a transaction auto match rate of almost 90%. 

Utilizing Journal Entry Automation, organizations can eliminate the need for manual data entry, reducing the risk of human error and ensuring that all transactions are recorded promptly and accurately. With pre-built journal entry templates, organizations can completely automate journal entry preparation and ensure automated posting to ERP once the task is approved. This enables organizations to achieve 95% journal entry automation. This feature is particularly beneficial for businesses handling high volume of transactions, where speed and accuracy are paramount.

Furthermore, the Reconciliation Control Tower from Highradius offers a centralized platform to manage and monitor the reconciliation process. This tool provides real-time visibility into the status of reconciliations, enabling businesses to identify and address discrepancies quickly. With comprehensive dashboards and reporting capabilities, the Reconciliation Control Tower ensures that all stakeholders have access to up-to-date information, facilitating better decision-making and improving overall financial governance.

By utilizing HighRadius’ Record-to-Report suite of reconciliation tools, businesses can achieve an error-free general ledger, streamline their financial processes, and enhance the accuracy and reliability of their financial reporting.

FAQs

1) What type of account is a clearing account?

A clearing account is a temporary account used to hold transactions until they can be properly categorized and finalized. It helps ensure that all financial transactions are accurately recorded and reconciled before being posted to their final destination accounts in the general ledger.

2) What is a cash clearing account?

A cash clearing account is a specific type of clearing account used to manage cash transactions. It temporarily holds cash inflows and outflows until they are matched and allocated to their respective accounts. This helps businesses track pending cash transactions and ensures accurate cash flow management.

3) What is a clearing account in banking?

In banking, a clearing account is used to process and settle transactions between different financial institutions. It temporarily holds funds during the clearing process until the transactions are fully verified and settled. This helps in ensuring that interbank transactions are accurately and efficiently processed.

4) What is a clearing account used for?

A clearing account is used to temporarily hold transactions until they can be accurately categorized and reconciled. It ensures that financial transactions are properly matched with corresponding records, reducing the risk of errors and maintaining the accuracy of financial statements.

5) What is a payroll clearing account?

A payroll clearing account is a temporary account used to manage and distribute payroll funds. It holds the total payroll amount until individual employee payments are processed and verified, ensuring that payroll expenses are accurately allocated to the correct accounts and financial records.

6) What is a clearing account on the balance sheet?

A clearing account on a balance sheet is a temporary account that holds transactions until they can be accurately allocated to their final accounts. It appears as either an asset or a liability, depending on the nature of the transactions it holds. This helps in ensuring accurate financial reporting and reconciliation.

7) What is a fixed asset clearing account?

A fixed asset clearing account is a temporary account used to record costs related to acquiring and preparing fixed assets for use. It holds these costs until the asset is fully ready for use, at which point the accumulated costs are transferred to the appropriate fixed asset account.

8) How e-Commerce businesses benefit from using clearing accounts?

E-commerce businesses’ accounts temporarily hold funds from sales until all transactional details are verified, enhancing the accuracy of financial records and simplifying the reconciliation process. This helps ensure that financial statements reflect accurate and timely data.