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Receiving and accounting for advance payments from a client is a task that requires careful attention to the way entries are made in a company's accounting records. The process usually involves qualifying the type of payment received, and then completing the posts to the general ledger so that once the goods and services related to the payment are invoiced, that payment can be applied properly. While the exact process will vary slightly based on how closely the business makes use of generally accepted accounting principles, a few specific steps are highly likely to be used when posting those advance payments.
Steps
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Qualify the type of advance payment. This depends on whether or not the goods or services have been delivered. The advance payment is classed as earned revenue if the payment is for goods and services that have been partially or completely delivered to the customer, but have not yet been invoiced. [1] X Research source
- The advanced payment is classed as unearned revenue should the payment be for goods and services that will be delivered and invoiced at a future date, since the seller has not yet provided any benefits to the buyer. [2] X Research source
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Create a special account in the company accounting journal. Label it "Customer Deposits" or "Prepaid Sales." You might think a customer deposit would be straight income, but since you "owe" the customer something, it's actually a liability to the business.Advertisement
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Relate the advance payment to a customer account. If this is new client, create a customer account in the accounting records. The detail for the earned or unearned revenue should be posted in that account as well, pending further actions such as filling the order and creating the invoice for that order.
- For example, you would create an account called "Smith Metal Technology."
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Record the amount of the deposit from the customer. In your accounting journal, debit the Cash account and credit the Customer Deposits account in the same amount. Debits increase expenses, assets such as cash or equipment, and dividend accounts. Credits decrease these accounts and increase liability and equity accounts.
- For example, when Smith Metal Technology makes a $1,000 deposit, debit Cash for $1,000 and credit Customer Deposits for $1,000.
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When the work is completed, send an invoice to the customer. Note on the invoice the amount of the deposit previously paid and subtract it from the total amount owed. Revenue can be recognized when the work has been completed and the customer has been invoiced, not when the money is received.
- For example, if the total invoice is for $5,000, deduct the $1,000 deposit to total $4,000 owed.
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Record the transaction in your accounting journal. Revenues are credited $5,000, Accounts Receivable is debited for $4,000, and Customer Deposits are debited for $1,000. This is how you record the revenue to the company - by converting a liability (work owed) into an asset (accounts receivable).
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Post the advance payment. This will be on either the balance sheet or the income statement based on the payment classification (which is based on whether or not a percentage of the work/service has already been delivered). If classed as "unearned revenue", the amount may be posted to the company balance sheet as a liability under the unearned income/revenue line item. A notation that connects the revenue with the specific customer's account number will make it easier to move the balance once an invoice is created. [3] X Research source
- For example, on the balance sheet you would have a line item stating Unearned Revenue, $1,000 Smith Metal Technology, account number 589.
- Earned revenue can be posted to the company's income statement, once an invoice has been sent.
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Complete the transactions once the invoice is posted. This will move the unearned income from the balance sheet, since it can now be counted as a payment on a specific invoice number found in the open accounts payable and considered part of the receivables for the period. Earned income in like manner can be moved from an outstanding line item on the income statement applied toward the balance of the invoice.
- The income statement would state "Revenue $5,000" after the work is completed and the invoice sent.
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Keep good records. Paper copies of all documents related to each customer payment should be kept for at least one year until your accounts have been audited and your taxes filed. Then you can save documentation electronically for at least seven years.
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Tips
- Many accounting software packages include automated processes for posting advance payments according to accepted accounting principles. To manage the posting, all that is required is to enter the amount of the payment, class it as earned or unearned revenue, and relate it to a specific customer. The software then makes the necessary entries on the proper accounting sheets and statements.Thanks
- Slightly different methods may be used in different parts of the world. One approach calls for creating what is known as a pending or advance invoice and listing the advance payment as a credit on that invoice. Once the goods and services have been debited to the invoice, the credit is applied and the customer receives an invoice that reflects a zero balance or any remaining balance that the advance payment did not cover.Thanks
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Article Summary
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If a customer makes an advance payment, you’ll need to record it differently to regular payments, since it technically counts as a liability. First, create a new account called "Customer Deposits" or "Prepaid Sales" if you don’t already have one. Then, debit the Cash account and credit the Customer Deposits account for the amount of the advance payment. When the work is completed, invoice the customer with the advance payment subtracted from the total cost. For more tips from our Financial co-author, including how to post advance payments to company reports, read on.
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