How to Account for Customer Deposits

Co-authored by Darron Kendrick, CPA, MA

Last Updated: February 13, 2024

Sometimes a business needs to make a deposit of cash up front when placing a business-to-business order. This may be for an unusual one-time purchase such as for a large piece of machinery, or the business may not have the credit required with its supplier in order to be allowed to pay for the goods after delivery. There may also be times when you are the seller and have agreed to let your customer make a deposit on an order and to pay the balance after you deliver the goods or services. For example, this down payment might cover the cost of your raw materials. Regardless of the reasons behind down payments, accounting for them correctly is important. Below you will learn how to account for customer deposits, whether you are making or receiving a deposit for an order.

Method 1

Method 1 of 3:

Receiving a Prepayment Deposit

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1
Create an account called "Customer Deposits" or "Prepaid Sales" in your accounting journal. While a customer deposit sounds like straight income to you, it is in fact a liability to the business because you "owe" the customer something. This is why you need to create a special account.
- Think of an account as like a line item on your personal budget.
- Check to make sure that this "Customer Deposits" account has not already been created under another name.
2
Determine which accounts to debit or credit. All financial transactions must be entered in the company's general financial ledger. Each transaction is listed as a debit or credit and for every debit there must be a credit.
- Debits increase expenses, assets (such as cash or furniture) and dividend accounts. Credits decrease these accounts. An easy way to remember this is D-E-A-D (Debits-Expenses-Assets-Dividends).
- For example, if you are paying a utility bill you would debit accounts payable and credit cash.
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In your accounting journal, debit the Cash account and credit the Customer Deposits account in the same amount.
Note on the invoice the amount of the deposit previously paid and subtract it from the total amount owed.
5
Record that the invoice has been created and apply the deposit amount. Credit the Revenue account while debiting Accounts Receivable and Customer Deposits.
- Revenue is recognized when the work has been done and the customer has been billed, not when the money is received.

Method 2

Method 2 of 3:

Making a Prepayment Deposit

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Check to make sure that this "Down Payments" account has not already been created under another name.
Credit your Cash account and debit the "Down Payments" account for the amount paid. Down Payments are considered assets to your business.
This way you are turning an asset (down payment) into an expense when the vendor’s bill arrives. Credit Down Payments and debit Accounts Payable, which is a short-term debt payment that needs to be paid in order to avoid default.^{[1]
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This can include the balance of what you owe plus any shipping charges, for example. The remaining amount of what you owe for the goods or services will require a credit to Cash and a debit to Accounts Payable.

Method 3

Method 3 of 3:

Keeping Detailed Records

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For example, "paid cash for down payment on sewing machinery, January, 2015."
This is very important in case there are errors or for any questions later. Documentation on all entries can be filed by assigning a journal entry number and date as a packet. Anyone should be able to look up a journal entry in the general ledger and then go to the backup documentation easily.
You will need these until your accounts have been audited and your taxes filed.
Scan them, front and back, and keep those copies on two disks, one to be stored in the office and one off site to be used in case of emergency.

Expert Q&A

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Question

Is a deposit an expense or an asset?

Darron Kendrick, CPA, MA
Financial Advisor
Darron Kendrick is an Adjunct Professor of Accounting and Law at the University of North Georgia. He received his Masters degree in tax law from the Thomas Jefferson School of Law in 2012, and his CPA from the Alabama State Board of Public Accountancy in 1984.

Darron Kendrick, CPA, MA

Financial Advisor

Expert Answer

It depends on perspective. The deposit is an asset of the customer and a liability of the vendor.

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Think of a Customer Deposits account as a holding account for the money. It is used up as invoices are created or received against it.

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Because the process of accounting for down payments is a bit more labor-intensive, it is usually better to create a separate account for any vendor used consistently.

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Warnings

While you may be tempted to simply invoice your customer for a down payment, this is against Generally Accepted Accounting Principles (GAAP) and does not allow for a proper paper trail of the transaction. You cannot claim a deposit as revenue until you have provided the goods or service.

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