The customer advance is a liability account in which all customer payments for products or services that have not yet been delivered are stored. After the related goods or services are delivered, the amount in this account is transferred to the sales account.
Employers sometimes insist that their clients pay advances. It is usually needed when the value of an order is quite high or if the products ordered are very expensive.
The customer advance represents a part of the payment referring to the amount of the product that will be delivered later. Customers agree to make advances when these products are not readily available on the market or if there is an urgent need for the products.
This advance account is considered a short-term liability account, as the amounts stored in it are generally settled within the following twelve months. A company can meet its short term requirements with the help of customer advances.
How is customer advance recorded?
When a customer advance occurs, it is accounting correct to recognize the advance as a liability until the seller fulfills its obligations under the underlying sales contract. There are two journal entries involved, which are:
It is debited from the Cash account (assets) and credited to the customer‘s Advance account (liabilities).
It is debited from the customer‘s down payment (liability) account and credited to the sales account.
Customer advances should not be accounted for with records that are automatically reversed, to prevent the Cash account amount from reverting to the next month, despite the fact that the money received must remain in that account.
The right thing is to manually monitor the amount in the Customer Advances account monthly and transfer the amounts to the Sales account as the products are delivered or the service is provided.
This means that an additional step must be taken within the month-end closing procedure to ensure that the status of each customer advance is investigated regularly.
The ABC Company Music Store allows customers to purchase redeemable electronic gift certificates for music or devices that can store and play music.
In June, customers purchased $40,000 worth of ABC Company gift cards. Customers also purchased $35,000 worth of music from ABC Company in the same month with gift cards. The journal entry to record the advance would be as follows:
On the other hand, the journal entry to record the release of gift certificates would be as follows:
What are the reasons for the advance?
credit not approved
The seller is not willing to give the customer credit. For this reason, it requires you to be paid in advance.
A product can be so specific that if the buyer doesn’t pay, the supplier can’t sell it to anyone else; therefore, the seller must demand an advance payment from the customer.
Accounting cash basis
The customer may be operating on a cash basis of accounting and therefore wants to pay cash as soon as possible in order to recognize the expense and reduce its reportable income in the current fiscal year.
The customer can pay in advance to reserve the seller’s production capacity, or at least prevent a competitor from using it sooner.
Active or passive
Under the accrual basis, revenue received prior to its sale must be reported as a liability. If paid in less than one year, it must be shown as a current liability.
The customer advance is generally declared on the supplier’s balance sheet as a current liability. However, if the seller does not expect to recognize the underlying proceeds of the sale transaction in less than one year, the liability should be classified as a long-term liability.
When a customer provides a business with a cash advance prior to the sale being executed, that admitted amount will be recorded in the books with a debit to the asset’s Cash account and a credit to the customer’s Advance account or unearned income from liabilities.
As the amount received in advance is sold, through the accounting adjustment records, the liability account will be debited for the amount sold, in addition to crediting the sales account.
Current liabilities refer to debts that must be paid over the course of a year or an operating cycle.
Payment in advance
If a customer prepays for a product or service, that transaction becomes part of a larger group of liabilities, called Prepayments, being a component of the company’s liabilities that are definitively determinable, as they are known to exist and they can be measured. with accuracy.
When a company collects this money from a customer, there is an increase in cash with the corresponding increase in the customer’s advance on current liabilities. When the product or service is delivered, the customer‘s Advance balance will decrease and there will be a corresponding increase in the sales account.
Examples of customer advances
Customer advances are common in airlines, magazines, or newspapers, as the customer often pays for an airline seat or magazine subscription before flying the plane or receiving publications.
Gift cards or cards are another type of mutual agreement that involves paying in advance before providing a product or service.
Other examples are an insurance company receiving the protection premium for the next six months or a website building company receiving an advance from a client for future work.
Blue Item company receives $100 from a customer for a custom blue item. The company records the receipt with a debit of $100 to the cash account and a credit of $100 to the customer‘s down payment account.
The following month, Blue Item delivers the custom item and creates a new journal entry that debits the Customer‘s Advance account by $100 and credits the sales account by $100.