What’s a Prepayment and the Types of Prepayment?

A prepayment is when you put or receive money upfront for something you’re planning to receive or deliver later. Why have it? Well… businesses have prepayment as it provides them with security.

For example, if you wanted to book out a hall on a Sunday to host your birthday party and then decided you didn’t want to go ahead, the business, if they didn’t have anyone on standby to use the hall on that particular day, would have lost that anticipated money as a result of your cancellation. On both sides, a prepayment or ‘deposit’ just means that you’re ‘serious’ about going ahead with a purchase.

So what are the types of prepayments?

There are two types of prepayments.

  • Money out – when you pay for something in advance. E.g. down payment on venue hire. This may also be called expenses paid in advance, but commonly it’s a prepayment. This is an asset account in the accounting system because when you pay for something in advance, the money is still yours (an asset) until you get the good or service that you’re paying for.
  • Money in – when you receive a deposit in advance of doing something. E.g. someone pays you a deposit to secure your time to make them a customized piece of furniture. Sometimes this is called revenue received in advance. This is a liability account. Why? Because you’ve received money in advance and you own the person depositing this money if the services/goods are not delivered.

Next: Creating Prepayments in Xero – A Shortcut

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