Advance definition
/What is an Advance?
An advance is a payment made in advance of the performance of a service or product delivery. Advances may be required when the paying party has a poor credit record, or when the goods to be produced are highly customized. In the latter case, the product is so customized that the seller would be unable to sell it to another party if the initial buyer were to back out of the deal, and so demands an advance.
Characteristics of an Advance
An advance paid to a business by a customer has the following characteristics:
Payment for future goods or services. The advance represents payment made by the customer before receiving the goods or services. It is essentially a prepayment for products or services to be delivered in the future.
Liability for the seller. Until the goods or services are provided, the seller treats the advance as a liability on its balance sheet. It reflects the obligation to deliver goods or services or refund the amount if the agreement is not fulfilled.
No revenue recognition. The advance is not recognized as revenue at the time of receipt. Revenue is only recognized when the goods are delivered, or the services are rendered, adhering to the accrual accounting principle.
Legal basis. Advances are usually governed by a contract or agreement outlining the terms and conditions, such as the amount, timeline, and circumstances for potential refund or forfeiture.
Tax implications. Depending on the jurisdiction, an advance may have tax implications. For example, some tax authorities may require businesses to account for the advance as taxable income even before the goods or services are delivered.
Accounting for an Advance
If an advance is made by a customer, it is initially recorded by the recipient as a liability, since no performance has yet been completed. If the advance is made to a supplier, the payer records it as an asset, since no related receipt and consumption has occurred. A payment to an employee prior to the employee working the related hours is also an advance, and is initially recorded by the employer as an asset.
Presentation of an Advance
All types of advances are generally presumed to be liquidated within the next 12-month period. Thus, a customer advance would be classified on the balance sheet as a current liability. Or, an advance paid to a supplier is classified as a current asset. When the liquidation point is further out than 12 months, the advance is instead classified as a long-term liability or asset, respectively.