Does your business accept customer prepayments or retainers? Perhaps you sell gift certificates or packages of services to be used over a certain period of time or number of sessions. Are you aware that this money is not to be counted as income until the services have been rendered? This means a system needs to be set up to account for the funds properly.
If you post this payment directly to a revenue stream, you have overstated your income for that time period, and understated it for the remaining periods of time as services are provided. Proper accounting would be to post this as unearned revenue and process the income as services are rendered.
In most situations, the money you receive for retainers and gift certificates must be shown as a liability because those funds are due back to the customer if services are not provided. There are some exceptions where deposits are non-refundable, but those are still posted as liabilities until the service is provided or the customer loses their deposit.
So how do you handle this situation? The first step is to set up the proper liability such as unearned revenue, customer prepayments, or client retainer. Choose what description makes the most sense in your industry. As services are performed and the money is earned, you transfer the amount earned from the liability account to the income account. Let’s assume QuickBooks is the accounting software being used. The steps are as follows:
- Create a liability on your chart of accounts using the name you prefer that best describes your situation (for example customer prepayments)
- Create an item (non-inventory or service) to use on a sales receipt or invoice (you can use the same name as the liability account). You will map this item to the liability you set up in step 1
- Create a sales receipt (if you have already been paid) or an invoice (if customer will pay you on terms) using the item created to track the prepayment
- Once you have provided a service, create an invoice using your income items and amounts to charge for each. After all items are entered, add the customer prepayment item and enter the amount to use as a credit on this invoice as a negative. This will reduce what the client owes you (and if the prepayment covers the full amount of charges, the invoice will be zero).
Let’s use my business as an example. I have a customer with one employee who doesn’t want to pay an invoice each month for the services we provide, but would rather write one check in January for the year. We receive his check as a prepayment increasing the liability on the balance sheet. Each month we create an invoice for the service and apply the prepayment for a zero-dollar invoice. This increases our income for payroll processing and reduces the liability each month. When the December invoice is created, his prepayment has been reduced to zero. By doing the accounting this way, each month shows income rather than the full amount of the payment showing as income in January.
If you have questions on how to set this up in your bookkeeping, contact my office for assistance. We are here to help! 310-534-5577 or contact@abandp.com.