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Start Hiring For FreeRecording prepayments can be confusing for many small business owners.
Fortunately, Xero provides flexible tools to accurately track advanced payments, ensuring you recognize revenue appropriately while fulfilling obligations to customers.
In this guide, you'll discover step-by-step instructions for recording prepayments in Xero, whether entering them manually or utilizing automation, along with recommendations for avoiding common accounting mistakes.
Prepayments, also known as advanced payments, refer to money received from a customer before a product or service has been delivered. Tracking prepayments is an important accounting task for small businesses using Xero software.
A prepayment represents an obligation on the business to provide goods or services in the future. It allows customers to pay upfront for products or services they have ordered but not yet received.
For the business, prepayments provide cash flow and visibility into upcoming work. However, it is crucial to track prepayments accurately to avoid counting the money before fulfilling obligations or delivering the products/services.
There are several key reasons why properly recording prepayments matters:
Careful prepayments tracking prevents overstated revenue and ensures transparency into upcoming work and cash flow.
Xero provides automated accounting tools to simplify prepayments tracking including:
With streamlined recording of prepayments in Xero, small businesses can achieve more accurate revenue recognition, financial statements, and fulfillment of customer obligations.
On the Create tab, select "Add Details" to access the dropdown menu. Choose "Prepayment" and fill in the relevant details:
Once complete, save the prepayment entry. This will create a trackable prepayment asset on the balance sheet.
When you receive the invoice for services rendered or goods delivered against the prepayment, you can apply the prepayment amount to that invoice. This will automatically reconcile the prepayment tracker.
Using prepayment accounts and entries in Xero provides transparency into advanced payments and ensures proper tracking as services or products are fulfilled over time. Key benefits include:
With a few clicks, prepayments can be seamlessly handled in Xero without needing manual journals or repeating entries. This saves significant time while enforcing best practices around accounting for advanced payments.
RECONCILING AN ADVANCED PAYMENT
Set up a current liability account for this advance payment and make sure the "Enable payments to this account" option is selected. This will allow you to track the advance payment separately until it is reconciled.
Record the advance payment as a "Spend Money" transaction coded to the new liability account. This registers the inflow of cash and creates a balance in the liability account.
When you deliver the product or service relating to the advance payment, create an invoice in Xero as usual.
Allocate part or all of the advance payment to this new invoice. This will reduce the balance in the liability account as the advance is reconciled.
Repeat steps 3-4 as you continue delivering products/services to the customer. The advance payment liability will decrease with each allocation until fully reconciled.
Any remaining balance in the advance payment liability account represents services yet to be delivered in the future.
Reconciling advance payments in this way provides transparency in Xero, allowing you to accurately track the status of any customer prepayments. It ensures the cash is registered properly while also matching it against actual invoices over time. This prevents advance payments from getting "lost".
With a few simple account adjustments, advance payments can be seamlessly managed in Xero without manual calculation or tracking outside the system.
Recording prepayments in accounting can seem complicated, but following these key steps will ensure you account for them properly in Xero:
Make the upfront payment. When you pay for something in advance - like paying 3 months of rent upfront - record the transaction in Xero as you normally would through the bank feed, imported bank statement, or manual journal entry.
Enter a prepayment journal. Create a manual repeat journal in Xero crediting your Prepayments account and debiting your Bank account for the full amount paid. This tracks the prepayment as an asset on your balance sheet.
Allocate the prepayment over time. As you receive the prepaid goods or services, create manual journals to debit the relevant Expense account and credit the Prepayments account. This allocates a portion of the upfront payment to each period's income statement.
Set up repeating journals. To easily expense a portion of the prepayment each month, set up a repeating manual journal to debit the prorated amount to Expense and credit Prepayments automatically.
Following these 4 key steps ensures you accurately record the entire upfront prepayment transaction from initial payment to final allocation over time. Reach out to your accountant if you need help setting up the necessary accounts and journals in Xero.
Overpayments and prepayments are handled differently in Xero.
Overpayments sit as credits on existing sales invoices or bills. They can be:
For example, if a customer pays $120 but their invoice is only $100, there will be a $20 overpayment credit on that invoice. You can refund the extra $20, or apply it to their next invoice.
Prepayments are payments received before an invoice is issued or goods/services delivered. Unlike overpayments, prepayments:
When you receive a prepayment, you record it in a prepayment journal. Later, when you deliver the goods/services, you apply the prepayment to the invoice to reduce the amount owed.
The key difference is overpayments apply to existing invoices, while prepayments are payments for future invoices. Prepayments sit on the balance sheet until allocated, while overpayments create a credit on existing invoices/bills.
This section delves into the specifics of handling prepayments within Xero, detailing the accounting principles involved and the features Xero provides to manage them effectively.
When a business receives payment from a customer before delivering goods or services, this is considered a prepayment. Proper accounting of prepayments involves:
Later, when the product or service is delivered to the customer, the prepayment liability is reduced by:
This process adheres to the matching and revenue recognition principles in accrual accounting. It ensures revenue is only recorded after delivery, while also tracking prepayments separately until they are earned.
Manually recording prepayments as above can be tedious for high transaction volumes. Xero provides an automated Prepayments Tracker feature for simplified management:
This streamlines accounting for prepayments in Xero, especially useful for small businesses with many advanced payments.
The core accounting treatment for prepayments is consistent between manual journal entries and using Xero's Prepayments Tracker. However, the Tracker provides significant process efficiencies:
On the other hand, manual journals provide more flexibility for complex prepayment scenarios that don't fit Xero's predetermined workflow.
Overall, Xero's Prepayment Tracker dramatically simplifies prepayment management for many small businesses. But manual journals still have a place when specialized accounting treatment is required.
This section provides a comprehensive walkthrough on how to record prepayments in Xero, offering practical steps and tips to ensure accuracy and compliance.
When you receive a prepayment from a customer for products or services to be delivered at a future date, you need to record this transaction properly in Xero. Here are the key steps:
This records the prepayment funds as a liability until you fulfill the order. The key is linking the prepayment to the specific customer and tracking it over time.
Xero's Prepayments Tracker enables you to allocate prepayments received to specific products, quantities, and future dates when you will fulfill the obligation. To use it:
This greatly simplifies tracking when you receive cash upfront and need to fulfill orders later.
On the specified fulfillment date for any prepayments tracked:
This automatically clears the prepaid funds and satisfies your delivery obligation to the customer per the terms.
Key reports for visibility into prepayments include:
Running these reports periodically lets you track upcoming deadlines for open prepayment obligations.
Handling prepayments in accounting can be nuanced depending on the type of upfront payment received. As a small business using Xero, it's important to understand best practices for recording various advanced payments to ensure accuracy.
When a customer pays a deposit for a custom order to be fulfilled at a future date, it's essential to link the deposit to the obligation it represents. Here are some tips:
For ongoing services billed in fixed cycles, like subscriptions or retainers, prepayments require special handling:
For prepaid service packages or gift cards, use Xero's Prepayments feature:
For large projects with multiple phases, track deposits against work completed:
Careful handling of different prepayment types avoids ambiguity and keeps the books clean!
Prepayments or advanced payments can create confusion in financial reporting if not properly recorded. Here are some tips to avoid issues:
Premature income recognition overstates revenue and profits artificially. This causes problems when filing taxes and financial statements.
It's critical to reliably connect prepayments to the associated delivery of goods/services. Otherwise obligations can unintentionally go unfulfilled.
Keeping prepayments visible ensures they don't get lost or forgotten. Xero provides helpful accounting tools to track and manage advanced payments.
Following these tips will help avoid common prepayment pitfalls. The key is ensuring disciplined processes to record obligations accurately and fulfill promises reliably. This maintains proper books and keeps customers satisfied.
Accurately recording prepayments in Xero is critical for small businesses to maintain proper revenue recognition, cash flow visibility, fulfillment tracking, and financial reporting. There are two main methods for handling prepayments - manual journals and the Prepayments Tracker.
Manual Journals
Prepayments Tracker
Businesses should weigh the volume of prepayments and need for automation vs. simplicity.
Reliable prepayment processing requires:
With tight links between teams, prepayments can be smoothly integrated into financials and operations.
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