A customer deposit is money a customer pays before you deliver the goods. It is a liability, not revenue: the sale is recorded when the customer takes the goods, and until then the deposit sits on the balance sheet as money you owe back or owe in goods.
A customer orders a hot tub and pays $2,000 down, and the tub arrives in six weeks. Booking that $2,000 as a sale today overstates the month's sales, sales tax and commission.
A deposit is a liability
When a customer pays ahead, you owe them either the goods or their money back. That obligation is a liability. Accountants call the account customer deposits, or unearned revenue, or deferred revenue.
The accounting standard for revenue, ASC 606, says to recognize revenue when you satisfy your promise to the customer, which for goods means when control passes to them. For a store that usually means delivery or pickup. Until then the money sits on the balance sheet as something you owe. The FASB's summary of the standard is linked under Sources.
ASC 606 works in five steps:
- Identify the contract with the customer.
- Identify the promises in it (performance obligations).
- Determine the price.
- Allocate the price to the promises.
- Recognize revenue when each promise is satisfied.
For a hot tub sold on its own, there is one contract and one promise, so the whole price is recognized at step 5, on the day the customer takes control of the tub.
What moves at hand-over
Four things date from the day the customer takes the goods:
- Revenue. The sale is booked when the goods are handed over.
- Cost of goods. Inventory leaves the shelf and its cost becomes an expense on the same day, so the margin lands in one month.
- Sales tax. In most states the tax is owed on the sale, so it follows the delivery. States differ on which day's rate applies and when the tax is due, so check your state's sales tax authority. Idaho's is one example.
- Commission. A salesperson earns it on a completed sale, not on an order that may still cancel.
The entries, in plain terms
Take a $10,000 tub, a $2,000 deposit and a $6,000 cost, with tax left out.
| When | Account | Debit | Credit |
|---|---|---|---|
| Deposit taken | Cash | $2,000 | |
| Deposit taken | Customer deposits (liability) | $2,000 | |
| Delivery | Customer deposits | $2,000 | |
| Delivery | Cash or accounts receivable (the balance) | $8,000 | |
| Delivery | Sales revenue | $10,000 | |
| Delivery | Cost of goods sold | $6,000 | |
| Delivery | Inventory | $6,000 |
On the deposit day, cash and a liability go up and revenue does not move. On delivery, the liability is cleared, the revenue is booked, and the cost is matched to it. Account names vary from one chart of accounts to another; the debits and credits do not.
What goes wrong when a deposit is booked as a sale
- Sales are overstated. Orders you have not delivered show up as revenue, and a slow month looks like a good one.
- Tax timing is off. If tax is collected and reported when the deposit lands, you may remit tax on sales that have not happened, and use the wrong rate if the rate changed before delivery.
- Commission is paid early. The salesperson is paid on an order that might never be delivered, and then you are asking for it back.
- Cost of goods lags. Revenue arrives in one month and the matching cost in another, so margin swings from month to month.
- Refunds take more steps. A cancelled order that was booked as a sale needs a reversal of revenue, tax and commission. A cancelled order that was a deposit needs one entry: debit customer deposits, credit cash.
Partial deliveries
The tub arrives but the cover is on back order. A pool table is delivered and the accessories come later.
Treat each hand-over as its own sale. Book revenue, cost and tax for the part that went out. Apply as much of the deposit as the invoice needs and leave the rest in customer deposits for the part still owed.
Cancelled orders and refunds
If the customer cancels before delivery, the deposit is still a liability, so a full refund is simply debit customer deposits, credit cash. No revenue was ever booked, so nothing needs reversing.
If your terms let you keep part of the deposit, say a cancellation fee, the part you keep stops being a liability when the order is cancelled. It becomes income, and whether it is taxable depends on your state. State the fee in your order terms before the customer pays.
When a deposit is taxable income
Tax timing can differ from the books. Under Treasury Regulation 1.451-8, a business on the accrual method generally includes an advance payment in gross income in the year it is received. It may elect to defer the part not yet earned (or not yet in its financial statement revenue) to the next tax year, and no further. Payments for the sale of goods qualify. A business on the cash method generally reports income when it receives it. Publication 538 covers accounting methods, and your accountant decides which applies.
Questions
Is a customer deposit revenue?
No. It is a liability until you deliver the goods. Revenue is recorded when the customer takes control of what they bought.
Where does a customer deposit go on the balance sheet?
Under current liabilities, as customer deposits, unearned revenue or deferred revenue, until the order is delivered or refunded.
What is the journal entry for a customer deposit?
Debit cash and credit customer deposits when it is taken. At delivery, debit customer deposits and credit sales for the amount it covers.
Can I keep a deposit if the customer cancels?
Only what your order terms say, such as a stated cancellation fee. The part you keep becomes income when the order is cancelled, and the rest is refunded.
How Retavon handles it
Retavon is cloud-based point of sale and store management for specialty retailers. A sale counts at hand-over: revenue, tax, cost of goods and commission date from the hand-over, and money taken earlier is held as a customer deposit.
- The Customer Deposits balance is what has been paid on orders not yet handed over. The system checks that it equals what each order has been paid, less what has been handed over.
- Each hand-over posts its own journal entry, so a partly delivered order books only what went out.
- An order cancelled with money held can keep up to its cancellation fee, moved from Customer Deposits to fee income. The rest is refunded.
- Each store chooses whether the tax rate is the one on the order date or the one on the hand-over date, per its state's rules.
QuickBooks, or whatever accounting system you use, stays the book of record. Retavon posts balanced journal entries and exports them in batches. If the two ever disagree, the accounting system wins.
None of this is tax or accounting advice. How a store books deposits, fees and tax is for its accountant to decide.