Prepaid income definition
/What is Prepaid Income?
Prepaid income is funds received from a customer prior to the provision of goods or services. The prepaid income concept is usually seen in businesses that require prepayment for the manufacture of custom goods. It is not used in other industries, such as retailing, where payment is always made at the time of sale or later.
Accounting for Prepaid Income
Prepaid income is considered a liability, since the seller has not yet delivered, and so it appears on the balance sheet of the seller as a current liability. Once the goods or services have been delivered, the liability is cancelled and the funds are instead recorded as revenue.
Example of Prepaid Income
Fido Corporation manufactures custom-made dog kennels, which contain elaborate amenities. Since they are designed to the exacting specifications of dog owners, Fido insists on being paid up-front, before construction begins. In a recent case, a wealthy customer pays the company $50,000 for a custom dog kennel. Fido’s accountant records this payment as a $50,000 debit to the cash account and a $50,000 credit to the prepaid income liability account. Once the company delivers the kennel to the customer, the accountant debits the prepaid income liability account and credits the revenue account. These two entries mean that the payment started off as a liability and was then converted into revenue.
Terms Similar to Prepaid Income
Prepaid income is also known as unearned revenue.