Advance Payment

Advance payment is a payment made by a buyer to the seller before the actual scheduled time of receiving the goods and services. It protects the seller from the risk of nonpayment that could happen in the future. Additionally, it can help the seller financially produce or procure the goods or render services.

It appears on the assets side of the balance sheet as a prepaid expense for the buyer. Such advances are usually required when a buyer has defaulted payments in the past, so it protects the sellers from such unforeseen events, especially in the corporate world where the size of consignments is comparatively large.

Advance payment is the type of transaction where the payment for the goods or services is paid even before they are delivered. In other words, the supplier is paid before they commence their service. This is usually to ensure no default of payment is in scope after the product or service is delivered.

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. Moreover, It also shows the buyer’s trust in the seller as many of these advance payments are non-refundable.

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.

Without a doubt, advance tax can be a beneficial form of doing business for both the buyer and seller. However, it is important to understand its accounting as well. Let us understand how advance payment tax and other entries can be made for both the buyer and seller.

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 asset 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 debit cash or bank account and credit the buyer account with the same amount. The credit balance of the buyer account increases current liabilities. 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 this procedure, the institution or seller has to record the following transactions in the books of accounts:

• Revenue is credited
• Accounts receivable are debited
• The customer or buyer account is debited.

This concept is existent in various facets of daily live that we do not take notice most often. From daily use items to advance payment tax can be better understood through this section of the discussion.

'Prepaid cell phones' are examples 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.

Let us understand the importance of advance payment solutions with the help of the discussion below.

• 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 word, the seller will refund the prepayments into the customer's account.

One of the most significant risks with the advance payment solutions is for customers. They may get into trouble if the seller fails to fulfil 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.

Though they sound similar, advance payment and prepayments are two different terms. let us have a look at the below points to figure out how they differ:

• Prepayments 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.

This article is a guide to Advance Payment and its meaning. Here we explain how an entry in accounting is made for it along with examples, and vs prepayment. You may learn more about financing from the following articles –

• Prepayment Penalty
• Advance Refunding
• Notes Receivable
• Types of Credit