A transaction between two parties involves some form of compensation. For most businesses, it occurs through cash or bank payments. In most cases, these payments happen when a customer buys a product or service from a supplier or at a later date. Sometimes, however, customers may also pay in advance to secure a future transaction. This payment may appear as an advance to a supplier on the balance sheet.
What is Advance to Suppliers?
Advance to suppliers is a payment made to suppliers for a future transaction. Usually, it occurs when a customer aims to secure a transaction in the future. For example, a customer pays a supplier to ensure they receive products during the busy season. Some suppliers may also require an advance as security to complete a job or project.
Advances to suppliers are prevalent in some industries more than others. For example, suppliers may require customers to pay advances to fund equipment purchases for construction. Later, when the customer receives the product or services, the supplier counts the advance as a payment. Customers may also pay a portion of the total price in advance and the remaining after the transaction gets completed.
How to account for Advance to Suppliers?
The accounting treatment for advance to suppliers differs based on the party in consideration. Usually, it appears on the customer's balance sheet. For the customer, any amount paid in advance is an asset. On the balance sheet, it falls under current assets. In rare cases, it may also go under non-current assets if the delivery occurs after 12 months.
For the supplier, advance payments received from a customer are an obligation to deliver goods or services later. Therefore, it falls under the liabilities section in the balance sheet. However, suppliers may not use the same term to present it. Instead, suppliers may term it as advances from customers or treat it as deferred earnings. Usually, these advance payments fall under current liabilities.
What is the journal entry for Advance to Suppliers?
The journal entry for advance to supplier includes two stages. Firstly, when a company pays advances to a supplier, it records the amount as an asset. At this stage, the company has not received goods or services for payment. The journal entry to record this transaction is as follows.
| Dr | Advance to supplier |
| Cr | Cash or bank |
Later, when the company receives goods or services for payment, it must eliminate the balance. Since the payment has already occurred, the accounting treatment will be straightforward. The journal entry at this stage is as follows.
| Dr | Purchases |
| Cr | Advance to supplier |
Example
Red Co. paid a supplier an advance of $10,000 cash to secure a future transaction. At the time, the company used the following journal entry to record the transaction.
| Dr | Advance to supplier | $10,000 |
| Cr | Cash | $10,000 |
Four months later, Red Co. received goods from the supplier for which it had already paid the advance. The company recorded the transaction as below.
| Dr | Purchases | $10,000 |
| Cr | Advance to supplier | $10,000 |
Conclusion
Advance to suppliers is an account in the financial statements for prepayments to various suppliers. Usually, customers pay suppliers in advance to secure future purchases or as security for the transaction. The customer records this amount as a current asset in its accounts until it receives the products or services.
Originally Published Here: Advance to Suppliers: Definition, Accounting, Journal Entry, Examples
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