Journal entry for receiving advance payment

Introduction

In business, we may receive an advance payment from our customers for goods or services that we are going to provide them in the near future. In this case, we need to make the journal entry for receiving advance payment by recognizing and recording the cash received as a liability that we owe to our customers and have an obligation to fulfill in the near future.

Under the accrual basis of accounting, we cannot record the advance payment that we have received as revenue. This is because we have not earned such revenue since we have not delivered the goods to the customers or performed the services for the advance payment that we have received yet.

Likewise, the journal entry for receiving the advance payment from the customer will increase both our total assets and total liabilities on the balance sheet. And only when we have delivered goods to the customer or performed the service for such advance payment, should we recognize the revenue and eliminate the recorded liability accordingly.

Journal entry for receiving advance payment

We can make the journal entry for receiving advance payment from the customer by debiting the cash account and crediting the unearned revenue account.

In this journal entry, the unearned revenue account is a liability account on the balance sheet in which its normal balance is on the credit side. This unearned revenue account represents a liability that we owe to our customers. We need to fulfill this obligation in the future by providing the goods or services to our customers in order to convert this unearned revenue into earned revenue.

Likewise, after we have delivered the goods to our customer or performed the service for the advance payment that we have received, we can make the journal entry to record the earned revenue  with the debit of unearned revenue and the credit of revenue as below:

This journal entry is made to transfer the unearned amount of revenue to the earned amount as we have fulfilled our obligation to our customer that we owed due to the advance payment that we received previously.

Receiving advance payment example

For example, on December 20, we receive a $600 advance payment from one of our customers for the consulting service that we are contracted to provide in January, next month.

This $600 advance payment represents 30% of the $2,000 total fee that we charge on the consulting service that we will provide in January. And we will receive another 70% after completing the consulting service at the end of January.

In this case, on December 20, we can make the journal entry for receiving the advance payment of $600 by debiting this amount into the cash account and crediting the same amount into the unearned service revenue account.

December 20:

In this journal entry, both total assets and total liabilities on our balance sheet increase by $600 at the same time for the advance payment that we have received from the customer.

Later, after completing our consulting service at the end of January, we can record this $600 as the earned revenue by transferring this amount from the unearned service revenue account to the service revenue account as below:

After completing consulting service:

This journal entry is made to record our earned revenue of $600 as well as to remove the liability which is unearned service revenue that we have recorded on December 20. Likewise, this journal entry will increase our total revenues on the income statement by $600 and at the same time, it will decrease our total liabilities on the balance sheet by the same amount.

Additionally, when we receive another 70% of the total fee that we charge which is $1,400 ($2,000 x 70%), we can record another journal entry with the debit of the cash account and the credit of the service revenue account as below: