Journal entry for customer prepayment

Introduction

In business, we may receive the customer prepayment before performing the service or delivering the goods. In this case, we need to make the journal entry for customer prepayment by recognizing the amount received as a liability that we owe to the customer.

Under the accrual basis of accounting, we can only recognize the revenue after we have earned it. Likewise, as the customer prepayment is the money that we receive before performing the service, we need to record it as an unearned revenue which is a liability first. Only later, when we have performed and completed the part or all of the service that we have owed the customer, should we recognize and record it as revenue.

This is the same for the goods we have yet to deliver to the customer. For example, if we have received the customer prepayment for the goods that we have not delivered to the customer yet, we need to record it as an unearned revenue as well.

Of course, we may use the term “customer deposit” to specify that the money received is for the goods or services that we need to deliver to the customer in the near future. Though, the term “deposit”, in accounting, could be discussed further in whether it is a financial instrument or a non-financial instrument in nature. And of course, we do not include it in this article as it should be discussed in the article related to the financial instruments.

Journal entry for customer prepayment

We can make the journal entry for customer prepayment by debiting the prepayment amount into the cash account and crediting the same amount into the unearned revenue account.

Account	Debit	Credit
Cash	$$$
Unearned revenue		$$$

The unearned revenue account in this journal entry is a liability item on the balance sheet, in which its normal balance is on the credit side. Likewise, this journal entry is made in order to recognize the liability that exists at the time that we receive the prepayment from the customer.

Hence, this journal entry for the customer prepayment will increase the total assets on the balance sheet as the cash balance increases. And at the same time, it will also increase the total liabilities as we need to record the customer prepayment as an unearned revenue which is a liability item on the balance sheet.

Later, after we have fulfilled our obligation by performing the service or delivering the goods to the customer, we can make another journal entry to transfer the unearned revenue to the earned revenue as with the debit of the unearned revenue account and the credit of the revenue account.

Account	Debit	Credit
Unearned revenue	$$$
Service revenue		$$$

Customer prepayment example

For example, on June 30, we receive $5,000 of the customer prepayment that is made for our service that we will perform in the next month of July. As we receive this $5,000 amount before performing the service, we need to record it in the unearned revenue account as a liability on the balance sheet.

In this case, we can make the journal entry for the $5,000 customer prepayment as an unearned revenue by debiting this amount of $5,000 to the cash account and crediting the same amount to the unearned revenue account as below:

June 30:

Account	Debit	Credit
Cash	5,000
Unearned revenue		5,000

This journal entry will increase both total assets and total liabilities on the balance sheet by $5,000 as of June 30.

Later, in July, when we have performed and completed the service that the customer has paid us for, we can make another journal entry in order to transfer the $5,000 from the unearned revenue to the earned revenue as below:

After completing the service:

Account	Debit	Credit
Unearned revenue	5,000
Service revenue		5,000