How do I offset invoices between a debtor and a creditor?

Do you ever have a customer who is also your supplier?

That is, a customer to whom you sell goods and services, and they are also your subcontractor or a supplier supplying the components (or goods and services). Instead of exchange payments, some business owners may prefer to offset (contra) the invoices. 

For example, ABC Company, your debtor, owes you $10,000, and they are also your subcontractor (your creditor), which you owe them $3,000. Instead of paying you $10,000, they send you a payment of $7,000 and instruct you to offset the balance of $3,000 from the amount you owe them.

Offset invoices with a Bank account.

If the accountant agrees, some bookkeepers may 'shortcut' the process by receiving and paying the invoices in full with the bank account. It debits the bank $10,000 from the receipt, credits the bank $3,000 from the payment, and provides a net off of $7,000. It shouldn't be too bad if it is a one-off transaction, but reconciliation could be confusing if there are many.

Offset invoices with a clearing account.

Alternatively, you may use a clearing account instead of the bank to offset the invoices between the debtor and creditor (the contra amount). A clearing account is a dummy account, a bank type used to transit the contra amount between the debtors and the creditors.

After adding the clearing account to the MoneyWorks account list, you partially receive $3,000 from the debtor and deposit it into the clearing account. The second receipt is the $7,000 they paid, which you deposit into the bank account. Lastly, pay the creditor, ABC Company, $3,000 from the clearing account.

Use a Clearing Bank account to offset the invoices

The double-entry for the transactions are:

Receipt 1:

DR. Clearing account $3,000

CR. Accounts receivable $3,000

Receipt 2:

DR. Bank $7,000

CR. Accounts receivable $7,000

Payment:

DR. accounts payable $3,000

CR. clearing account $3,000

The clearing account method could be more precise and straightforward to reconcile. The clearing account always has a zero balance, and the bank only shows the funds received from the debtor or payment to the creditor, which will be less confusing when processing the bank reconciliation.

Offsetting could be complicated when the debtor and creditor are not the same company or when multiple currencies are involved.

For example, ABC Company could be your creditor, and instead of you paying them, they request to offset with your debtor, who could be their subsidiary. If the debtor and creditor are in a different foreign currency, you must translate the currency besides offsetting the amount. 

Contra outstanding between a debtor and a creditor could be tricky; avoid it if possible.