It’s important to account for all revenue you receive in advance. Here are the steps:
1. Qualify
First, what type of advance payment is it? That depends on whether or not you’ve delivered the products or services.
Earned revenue: The payment for products you’ve delivered to the customer but that have not yet been invoiced.
Unearned revenue: The payment for products or projects you’ll complete and invoice at a future date. Here, the buyer hasn’t yet received the goods/services.
Next, establish your deferred revenue account. Remember that your buyer’s down payment isn’t straight revenue – it’s a liability to you.
Third, associate the payment to the right client account. Be sure you’ve created an account for each new buyer. You should then record the earned and unearned payments in that account.
2. Account for the upfront amount
According to the accrual accounting method, you should report unearned income as a liability. So list any advance payment received within a year as a current liability:
Debit your cash account
Credit the liability (customer deposits) account in the same amount as the advance
Just a reminder: debits increase assets, expenses, and dividend accounts. On the other hand, credits reduce these accounts and increase equity and liability accounts.
After completing a sale or project, send your customer an invoice that includes what they owe you currently (total payment minus down payment).
Revenue recognition occurs when you’ve fully delivered the project and invoiced the customer, not when you’ve received the money.
Remember to:
Credit the revenue account
Debit accounts receivables
Debit the liability (customer deposits) account
3. Reporting
Depending on the type of advanced payment, report it on your income statement or balance sheet as follows:
Unearned income: Report it on the balance sheet.
Earned income: Post it on your income statement once you’ve sent an invoice.
Once you’ve invoiced the customer, report the invoice to the appropriate records. This moves the unearned revenue from the balance sheet because you can now link it directly with an invoice number you allocated to the client’s account. Similarly, move earned revenue on the income statement against the invoice.
