Using Credit Invoices to Record Customer Prepayments

Previously we posted an article on best practice for recording customer prepayments. That article is geared for smaller volumes of transactions and especially for those that do their accounting on a cash basis. However, it doesn't really conform to accounting best practices if you want to properly handle things in an accrual basis. For reference, you can see the other article here.

This guide will focus on recording and managing prepayments with a proper accounting liability account. It is more work, but your books will also be more accurate as you will show the prepayments as a liability rather than as a credit against Accounts Receivable. Your income will also be properly stated as when the work is invoiced, rather than when payment is received. Both of these are important distinctions in accrual-based books. It also allows you to send a document (such as an invoice) to your client to ask for payment.

The first step to use this method is to create an account to store the liability. Go to your Chart of Accounts (Gear / Chart of Accounts), then add a New Account. The account should have a type of "Other Liability" and name it "Customer Prepayments" as shown in this picture:

Now that we have an account, let's set up a Service Code to use when invoicing that properly references the new account. Go to the new Services Screen (Gear / Products and Services / Service) and set up a "Customer Prepayments" Service Code, like in this picture:

Your responses on these fields are important for this to work. Primarily you can call it anything you want and describe it however you wish for it to appear on the invoices. You can always change the description when adding it to an invoice if you feel it is necessary. The important fields here are the Income Account, which must be set to the liability account you created above, and remove the check next to the Taxable box. You also don't purchase this item so leave that box unchecked.

Now you are ready to invoice your customers for their deposits or prepayments. Whenever you need to invoice them, simply create a new invoice and use the new Service Code on your invoice, similar to this:

In this case we invoiced the Browers for a $500 prepayment. They will then pay the invoice, or if you have already collected payment enter the payment against the invoice manually. If you were to look at your Balance Sheet, it will show $500 in your Customer Prepayments liability account -- making your accountant happy.

Finally, when you invoice your client for your services, you will want to apply a portion of the prepayment against that invoice. Once your invoice is created (either created automatically from our Home Watch App for Method:CRM or entered manually into QuickBooks) you can open up the invoice and add a line to apply the credit balance, or a portion of it, the invoice as shown here:

Here you can see we used the new Customer Prepayments Service Code, the same one used to record the deposit, as the service on the line, and we entered the amount we want to apply in the Amount column. In this case we applied $150 against the invoice which brings the net amount to Zero.

Your books will show the liability amount reduced by what you applied, your income will be properly reflected by the income lines on the invoice, and your accounts receivable will show zero as you have nothing due.