Journal Entry for Advance Received from Customer
Advance is the amount of cash that customers paid to the company before receiving goods or services. Some kinds of purchases require the customers to pay a certain portion of the selling price during the order. After receiving an advance, company has the obligation to deliver goods or services.
It depends on the supplier’s policy to demand a percentage of the purchase when customers process orders with them. The company wants to ensure that customers are willing to make purchases. It prevents the customers from placing the order and canceling it later. It will be a problem if the products are unique and build specifically for the customers. So if the customers cancel the order after the production is completed, the supplier will be stuck with the products as it is hard to find the buyer to fit with the product specifications.
Advance is also required when the customer has a low credit score. Suppliers need to ensure payment collection before providing services or goods. It helps to reduce the uncollectable receivable. It may damage the relationship with the customer, but it helps to prevent loss when customer cannot settle the accounts receivable.
Moreover, the supplier will require a deposit when the products are very expensive. Supplier does not have enough capital to purchase or produce, so it requires the buyer to make a deposit. Some customers pay in advance to ensure the availability of the product on the exact date. It happens when the products are in high demand, and they may run out of stock in the future. It also helps the buyer to lock the price with supplier.
Journal Entry for Advance Received from Customer
When the company receives a cash advance from the customers, they need to record cash in but they cannot record the revenue as the goods/service are not yet provided. They need to record it as the unearned revenue which is the current liabilities.
The journal entry is debiting cash and credit unearned revenue. We can create chart of account “customer deposit” which is easy to control.
The journal entry will increase cash on balance sheet. It also increases the customer deposit which is the current liabilities on balance sheet. Company may use a different account name but as long as it is under current liability, it will be fine.
When the company delivers goods or services to customers, it is time to record revenue. They need to reverse the customer deposit to revenue as the company has already completed the obligation for the customer.
They should make journal entry by debiting customer deposits, accounts receivable,s and credit sale revenue.
The journal will eliminate customer deposits from the balance sheet. Sale will be present on the income statement and it is equal to the total purchase amount. Accounts receivable is the difference between total amount and deposit. Mostly, the customer only deposits a proportion of total amount, so the company needs to record accounts receivable to collect the remaining balance.
Journal Entry for Advance Received from Customer Example
ABC is a manufacturing that makes various types of clothes. On 01 April, a customer has ordered 100,000 units of custom uniforms which is a special design.
After negotiation, ABC and customer agree with the price of $ 10 per unit. However, due to a unique design, ABC will not be able to sell the uniform to others if customer cancels an order due to various reasons. So they decide to ask the customer to deposit $ 30,000 at the beginning even before the production started.
On 30 April, the production complete and ABC deliver the completed goods to the customer along with the invoice.
Please prepare the journal entry on the order date and completion date.
On 01 April, the customer place order and make a deposit to the company ABC. So the company needs to record the cash and liability to the customer.
The journal entry is debiting cash and credit customer deposit.
The transaction will increase cash on balance sheet which can be cash on hand or cash at bank. The customer deposit is the current liability which represents the company obligation to produce the goods for customer.
On 30 April, the company has completed the production and deliver goods to customer. So it is time to recognize revenue.
We have looked at the revenue recognition criteria as below:
- Risk and rewards have been transferred: since the goods are delivered to customer so it means they take full ownership and risk of the goods.
- Seller controls the goods.
- Amount of revenue is measured reliable: since both parties agree and sign a contract with amount of $ 100,000.
- Cost is measured reliable: the company already completed the production so the cost is already calculated.
- The seller is sure about the collection possible: customer accepts both goods and invoices.
On 30 April, company needs to record a revenue of $ 100,000. The customer deposit of $ 30,000 needs to reverse to revenue as the company has already completed the obligation. However, customers need to pay an additional $ 70,000, which is recorded as accounts receivable on seller’s balance sheet.
The accounts receivable will be present on the balance sheet, and it will be eliminated when customers make payments. Customer deposit needs to remove and sale is recorded into income statement.