Advance Payment Meaning Examples How To Account For It

Advance Payment Meaning

How to Account for Advance Payment?

For Buyer: A buyer making an advance to the seller shall record the transaction by debiting the seller’s account and crediting the cash or bank account. We show the debit balance of the seller account as a current assetCurrent AssetCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more in the books of accounts of the buyer until the goods or services are received and the invoice issued.

For Seller: To account for an advance, the seller needs to debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. read more cash or bank account and credit the buyer account with the same amount. The credit balance of the buyer account increases current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more. Once the customer receives the required goods or services, the seller or institution has to send an invoice to the customer. The invoice contains the total amount owed after subtracting it. Once completing all this procedure, the institution or seller has to record the following transactions in the books of accounts:

Revenue is creditedAccounts receivable are debitedThe customer or buyer account is debited.

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Examples

‘Prepaid cell phones’ is an example of an advance payment. The customer has to make payment for the prepaid cell phone in advance to enjoy its benefit for a month. The service provider only provides service for one month when it receives the prepayments. Likewise, ‘Prepaid rent’ or ‘utilities’ are other examples.

The other important example is the U.S taxpayers’ receiving advance payments from the premium tax credit (PTC). It helps the citizens in household activities and for other purposes. The due money of the taxpayer is paid to the insurance company in advance.

Advance Payment in Businesses

Companies involved in the manufacturing process need payment in advance as it will show commitment from the buyer’s side that they are willing to purchase and will buy it in the future. It protects the business from unforeseen losses. It also shows the buyer’s trust in the seller as many of these advance payments are nonrefundable.

It provides capital to the seller to construct the required goods or services. And it saves the seller from using their wealth or taking a loan to make the product.

Advance Payment Guarantee

PrepaymentsPrepaymentsPrepayment refers to paying off an expense or debt obligation before the due date. Often, companies make advance payments for expenses as well as goods and services to shed their financial burden. Advance payments also act as a tool to attain monetary benefits. Examples of prepayment include loan repayment before the due date, prepaid bills, rent, salary, insurance premium, credit card bill, income tax, sales tax, line of credit, etc.read more protect the sellers from unforeseen losses, but it is a bad deal for buyers as it poses a risk for them. If the seller cannot deliver the goods on time, buyers could be in a difficult position. For this purpose, an advance payment guarantee serves buyers as insurance by protecting them from such a situation. According to this, if a seller somehow can’t deliver the goods on time, the institution or the seller has to refund all the prepayment to buyers. Therefore, buyers can consider the deal void if the seller cannot deliver.

Importance

Protection to the Seller: Advance payment protects the seller from the buyer with a bad credit score and nonpayment.Provides Financial Assistance: Provides financial assistance to the seller in making the goods.Trust Builds Up: Trust is the most critical and difficult thing in the business to earn, and when a buyer makes a prepayment even for the nonrefundable deals, the trust between the buyer and the seller grows.Guarantee to the Buyer: The guarantee assures the buyer that if the seller is unable to stay on its words, the seller will refund the prepayments into the customer’s account.

Risks with Advance Payment

One of the most significant risks with the advance payment is for customers. They may get into trouble if the seller fails to fulfill the deal. In addition, it might be challenging for buyers to get their money back once the company they invested in is declared bankrupt. Most buyers prefer to make payments only when they get what they want.