Why money received in advance is a liability
Why a deposit or upfront payment sits as a liability until you deliver, what booking it as income does to profit, and how to explain it to a lender.
By Achekam · · 5 min read · For Running a business businesses in South Africa, Nigeria, Kenya
A customer pays you today for something you will deliver next month, next term or next year. The money is in your bank, and it feels like income. Your accountant then puts it on the balance sheet as a liability, alongside the overdraft and the amounts owed to suppliers, and the profit for the month looks smaller than the bank balance suggested. Owners often see this as accounting being awkward. It is accounting being accurate.
Gyms selling annual memberships, schools collecting fees for a term, event organisers selling tickets early, software firms billing a year upfront, and builders taking a deposit all face the same question. This article explains why the money is a liability, what happens if it is treated as income, and how to explain the result to someone who lends you money.
You owe the customer something
Investopedia defines deferred revenue, also called unearned revenue, as a payment a company receives in advance for products or services it has not yet delivered. It explains that this is a liability because, until the company delivers, it owes the customer the promised goods or services, or a refund.
That is the whole idea. The customer has not given you the money; they have exchanged it for a promise. Until the promise is kept, the business is in their debt, just as surely as it would be if it had borrowed the money. Once the work is done, the obligation falls away and the amount becomes revenue.
Investopedia also notes that IFRS 15 and the US standard ASC 606 require businesses to record upfront payments as contract liabilities and convert them into revenue as they complete their obligations to customers. Businesses reporting under IFRS in South Africa, Nigeria and Kenya are working to the same principle.
What happens to profit if it is booked as income
Investopedia notes that without deferring revenue, a company might overstate its profits in periods of large upfront payments. A worked example in words:
A fitness club sells most of its annual memberships in January, when people make resolutions. If all that money is recorded as January income:
- January shows an enormous profit, because a year's revenue sits against one month's costs.
- February to December show losses, because the costs of running the club continue while little new revenue arrives.
- The year in total may be right, but every month inside it is wrong, and decisions made on January's figures (a bonus, a new lease, a dividend) are made on a profit that has not been earned.
Spreading the revenue across the months of membership gives each month its share of income to set against its costs. The monthly figures then describe how the club is actually doing.
More liabilities, and more apparent borrowing
There is a side effect that surprises owners. Investopedia notes that a high deferred revenue balance increases total liabilities and can temporarily make a company seem more leveraged.
A lender running quick ratios on your balance sheet may see liabilities that look large against your assets and worry. In fact, much of that "debt" will be settled not with cash but with the service you were going to provide anyway. A business with a large deferred revenue balance often has strong cash and committed customers, which is a good position, provided it can deliver what it has sold.
Holding advances in Achekam
There are several ways money paid in advance can reach your books in Achekam, and each needs its own handling.
A payment before any invoice
A business records customer payments against one invoice or spread across a customer's invoices. A part payment leaves an invoice part-paid, and any extra is held on the customer's account. A deposit received before you invoice can therefore be held on the customer's account until the invoice is issued, rather than being treated as a sale.
An invoice issued upfront
Issuing a customer invoice posts it to the ledger as debtors, sales and output VAT straight away. If you invoice a year's service on day one, the full amount lands in sales. To defer it, use a manual journal: each business has its own chart of accounts, accounts can be added, so you can open a deferred revenue (or income received in advance) liability account, move the unearned part there, and release a month's share back to sales each month. Achekam refuses an unbalanced journal or one dated in a closed month, so each month's release has to be posted before the month is closed. Our article on deferring annual invoices by journal walks through the entries.
Gift vouchers at the till
Gift vouchers are sold at the till with a code and held as a liability until redeemed by that code, and they are sold without VAT. They are a small but clean example of money received in advance kept off the income line until it is earned.
The management accounts then show the result: an income statement for the period beside the period before, and a balance sheet at period end with the deferred revenue among the liabilities.
Explaining it to a lender or investor
When someone outside the business reads your balance sheet, give them context before they draw conclusions:
- Name the line. Show deferred revenue as its own liability, not mixed into payables, so it can be identified.
- Explain what settles it. Say plainly that it will be settled by delivering goods or services already sold, not by paying cash out.
- Show the trend. A deferred revenue balance that grows year on year usually means more customers paying ahead, which is a strength.
- Show you can deliver. The real risk is that you cannot deliver and have to refund. Show the costs of delivering are covered.
For industry examples, see annual memberships paid upfront and ticket pre-sales before an event.
Read further
Investopedia's article on deferred revenue and why it is a liability covers how upfront payments are recognised over time. List every type of advance payment your business takes, decide which account each belongs in, and agree with your accountant how and when each month's share moves into revenue.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
