Advance from Customer
An advance from a customer is a payment made by a customer to a business before the business has provided the goods or services agreed upon. This payment is considered a liability for the business because it represents an obligation to deliver the goods or services in the future.
When a business receives an advance from a customer, it records the transaction as follows:
Debit: Cash (Asset) – for the advance payment amount
Credit: Unearned Revenue (Liability) – for the advance payment amount
As the business provides the goods or services, it gradually recognizes the unearned revenue as earned revenue:
Debit: Unearned Revenue (Liability) – for the portion of goods or services provided
Credit: Revenue (Income) – for the portion of goods or services provided
This process continues until the business has fully delivered the goods or services, and the entire unearned revenue amount has been recognized as earned revenue.
Example of an Advance from Customer
Let’s say that a web design company receives a $6,000 advance payment from a client for a website development project. The project is expected to be completed in three months. Here’s how the transactions would be recorded:
When the advance payment is received:
- Debit: Cash (Asset) – $6,000
- Credit: Unearned Revenue (Liability) – $6,000
As the web design company completes portions of the project over the three months, it will recognize the revenue. Assuming the work is evenly distributed over the three months, the company would recognize $2,000 of revenue each month:
At the end of Month 1:
- Debit: Unearned Revenue (Liability) – $2,000
- Credit: Revenue (Income) – $2,000
At the end of Month 2:
- Debit: Unearned Revenue (Liability) – $2,000
- Credit: Revenue (Income) – $2,000
At the end of Month 3:
- Debit: Unearned Revenue (Liability) – $2,000
- Credit: Revenue (Income) – $2,000
By the end of the three months, the entire $6,000 of unearned revenue has been recognized as earned revenue, and the web design company has fulfilled its obligation to the client.
