Cash received in advance is a common occurrence in many businesses, especially those that provide customized products or services, require security deposits, or offer subscription plans. When a business receives cash from a customer before delivering the goods or services, it has an obligation to fulfill the order in the future. Therefore, the cash received in advance is not revenue yet, but a liability that must be recorded in the accounting books.
Contents
How to Record Cash Received in Advance?
According to HighRadius, when advance payments are received within a year, they are recorded as current liabilities. For accounting an advanced payment, it is essential to debit the cash account and credit the customer’s deposit account with the same amount.
For example, suppose a business receives an order from a customer to manufacture a product and requires $15,000 cash advance from the customer. The journal entry to record this transaction will be as follows:
| Account | Debit | Credit |
| — | — | — |
| Cash | $15,000 | |
| Customer Advances | | $15,000 |
This entry shows that the business has received cash from the customer, but also has a liability to deliver the product in the future. The customer advances account is shown on the liability side of the balance sheet as the related revenue is still unearned.
How to Recognize Revenue from Cash Received in Advance?
As per the accrual basis of accounting, revenue is recognized when it is earned, not when it is received. Therefore, when the business delivers the goods or services to the customer, it can recognize the revenue from the sale and reduce the liability of customer advances.
The journal entry to recognize revenue from cash received in advance will be as follows:
| Account | Debit | Credit |
| — | — | — |
| Customer Advances | $15,000 | |
| Revenue | | $15,000 |
This entry shows that the business has fulfilled its obligation to the customer and earned the revenue from the sale. The customer advances account is reduced by the amount of revenue recognized and the revenue account is increased by the same amount. The revenue account is shown on the income statement as part of the business’s income.
How to Account for Partial Performance of Work Related to Cash Received in Advance?
Sometimes, the business may not be able to deliver the entire order at once, but may perform some part of the work related to cash received in advance in a given period. In such cases, the business can recognize revenue proportionately to the extent of work performed and reduce the liability accordingly.
For example, suppose in the previous scenario, the business performs one-third of the work related to $15,000 cash received in advance in a given period. The journal entry to account for this partial performance will be as follows:
| Account | Debit | Credit |
| — | — | — |
| Customer Advances | $5,000 | |
| Revenue | | $5,000 |
This entry shows that the business has performed one-third of the work related to $15,000 cash received in advance and recognized one-third of the revenue accordingly. The customer advances account is reduced by $5,000 and the revenue account is increased by $5,000. The remaining liability of $10,000 will be recognized as revenue when the rest of the work is completed and delivered to the customer.
Conclusion
Cash received in advance is a common accounting transaction that requires careful recording and recognition of revenue. When a business receives cash from a customer before delivering the goods or services, it must record it as a liability and not as revenue. When the business delivers the goods or services or performs some part of the work related to cash received in advance, it can recognize revenue proportionately and reduce the liability accordingly. This way, the business can ensure that its accounting records reflect its true financial position and performance.
