Advances from Customers

Definition

The term advances from customers refers to money collected by a company prior to providing a product or service.  Advances from customers are oftentimes collected when businesses sell prepaid subscriptions or gift certificates.

When companies collect this money, the intention is to eventually provide the product or service paid for by the customer.  Following the receipt of this cash, the company would classify the advance as a current liability on the balance sheet.

Explanation

Current liabilities are defined as debts that must be paid within one year or one operating cycle, whichever is longer.  When a customer pre-pays for a product or service, this transaction becomes part of a larger group of liabilities from advanced collections, which is a component of the company's definitely determinable liabilities, since it's both known to exist and can be measured precisely.

Advances from customers are commonplace in the airline, magazine or newspaper industries, whereby the customer usually pays for a seat on a plane, or a magazine subscription, prior to receiving the publications or flying on the airplane.  Gift certificates, also known as gift cards, are another common arrangement that involves the collection of money in advance of providing a product or service.

When a company collects this money from a customer, there is an increase to cash and a corresponding increase to the current liability unearned revenue.  When the product or service is rendered, the balance in unearned revenue decreases, and there is a corresponding increase to revenues.

Example

Company A's popular music store allows customers to purchase electronic gift certificates that are redeemable for songs or devices that can store and play songs.  In the month of July, customers purchased $50,000 in gift cards from Company A.  Customers also purchased $65,000 in songs from Company A in that same month.

The journal entry to record the collection of the advance payment would be as follows:

  Debit Credit
Cash $50,000  
Unearned Revenue   $50,000

While the journal entry to record the redemption of the gift certificates would be as follows:

  Debit Credit
Unearned Revenue $65,000  
Revenue   $65,000

Related Terms

current liabilities, definitely determinable liabilities, liabilities from advance collections, collections for third parties, refundable deposits, unearned revenue, current maturities of long-term debt