Journal entry for prepayment received

Introduction

In business, we may receive the prepayment from the customers for the service or the goods that we will provide in the near future. In this case, we need to make the journal entry for prepayment received as a liability that we owe to the customer from the time of receiving the cash.

Under the accrual basis of accounting, we can only record the revenue when it is earned. Likewise, receiving the prepayment from the customer before providing the service or delivering the goods should be recorded as an unearned revenue which is a liability on the balance sheet.

Later, this liability can be eliminated after we have fulfilled our obligation by providing the service or delivering the goods to the customer. In this case, we can transfer the amount in the unearned revenue account into the revenue account for the amount that is earned.

Likewise, the journal entry for the prepayment received will increase both total assets and total liabilities on the balance sheet. And of course, there shouldn’t be any income statement item recorded at this point in time yet.

Journal entry for prepayment received

We can make the journal entry for prepayment received by debiting the amount received into the cash account and crediting the same amount into the unearned revenue account.

This journal entry is made to account for the cash received from the prepayment as well as to recognize our obligation that we need to fulfill in the future. Likewise, this journal entry of prepayment received will increase both total assets and total liabilities on the balance sheet by the amount of prepayment received.

Later, when we have fulfilled our obligation by performing the service or delivering the goods to the customer, we can make another journal entry to eliminate the amount of the liability that we have recorded with the debit of the unearned revenue account and the credit of the revenue account as below:

This journal entry is made to eliminate the amount of unearned revenue that we have recorded as well as to record the revenue that we have earned after performing the service or delivering the goods. Likewise, total revenues on the income statement increase by the amount of earned revenue while total liabilities on the balance sheet decrease by the same amount.

Example for prepayment received

For example, on June 30, we receive a $3,000 cash prepayment from one of our clients for the training service that we will perform at the beginning of July next month. This $3,000 cash prepayment is for the internal audit training course that we will provide on the first week of July and we expect to complete it at the end of the same month.

In this case, we can make the journal entry for the $3,000 prepayment received from our client on June 30, by debiting the cash account and crediting the unearned revenue account with this $3,000 amount as below:

On June 30:

In this journal entry, both total assets and total liabilities on the balance sheet increase by $3,000 after receiving the $3,000 prepayment as of June 30.

Later, when we complete the training service, we can make another journal entry to transfer this $3,000 from the unearned revenue account to the revenue account as below:

After fulfilling the obligation for the $3,000 prepayment:

In this journal entry, total liabilities on the balance sheet will decrease by $3,000 as a result of eliminating the $3,000 unearned revenue that we have recorded on June 30. At the same time, total revenues on the income statement will increase by $3,000 as a result of recording the revenue that we have earned from delivering the training service to the client.