Prepayments received

As it happens, in normal course of business you may be paid in advance for something that you still have to do. You will be given resources to use and as such, you have taken a liability on your balance sheet. You are given money in return for a promise to provide a service or sell something in near future. As such the company has a legal liability and this is recognized as one.

When the prepayment is received the entry in the accounting is this:

Dr Cash or cash equivalent

Cr Prepayment received

With this you increase the liability for future actions that you have to do (i.e. revenue still to be earned) and on the other side you gain an asset (resources received).

Those prepayments are just cash inflows and not recognized in revenue when initially booked. When the period arrives for which this prepayment relates to however, the following income entry is made:

Dr Prepayment received

Cr Revenue

Since you have now fulfilled your obligation, you are therefore entitled to recognize the proceedings from it as your performance results. The revenue is with this recognized in the period it relates to and not when cash is received.

Things get more interesting when those prepayments relate to a longer period. What is done then, is the same entry as above, only the amount is not full, but portion of the prepaid amount. Let’s say that you have received as prepayment 100 EUR for a 10 month period. The first entry is as follows:

Dr Cash or cash equivalent 100

Cr Prepayment received 100

Now the next entries are all similar and made for the next 10 month:

Dr Prepayment received 10

Cr Revenue 10

We strongly suggest having a list of all your prepayments as well their periods in one compact table. With more than a few items this may get confusing as well as some items are bound to be forgotten.