How To Account Vendor Prepaid Expenses and Deposits

Vendor Prepaid and Deposit Expenses are two common accounts that could be easily slipped and ignored among 100 of daily accounting tasks. You want to take extra precautions about both of the accounts, or your book won’t be as correct as it is expected.

Vendor deposit is organization’s investigate that made out of its box to vendors before receiving merchandises or services firm request. It is an in advance payment, and deserves very serious attention, proper record and control. Loosing them from your observation may cause a loss on the organization side—making payment for merchandises or services that never received by the firm.

Prepaid has no potential loss but it could become a big company project on the year-end closing if you do not assign them on timely basis every month. Hence it is another most important account that could be easily neglected. Hence, there must be a solid system to take precautions of both accounts. How to treat & accounts them? Read on carefully…

Why Do Vendor Deposit & Prepaid Expenses Exist?

It is not uncommon to face the requirement of an in advance deposit on some services such as utilities or rent. The deposits are generally held for a certain time, & then are either back to you or applied as a credit amount to your balance by the vendor. Sometimes, vendors want you to prepay amount all or part of an expense you are earn.

Prepaid expenses are generally tracked under the following situation:

  • Few vendors may ask for a prepayment on a large scale order if you do not have a buyer history with the vendor.
  • Some expenses (e.g. insurance) may require an yearly or semi-yearly payment that your accountant wants to expense 1 month at a time.

The payment you remit for any of these transactions or business fall into the definition of an ASSET—it’s firm’s cash even though other firm or someone else is holding it.

To track these settlement you have to create an asset account for ‘Deposits Held by Others‘ or/and an asset account for ‘Prepaid Expenses’. Both of these are grouped together in the ‘Current Assets’.

The reason I guessed naming the asset account as ‘Deposits Held by Others’ is, to make sure you do not confuse it with accounts that track deposits you are holding for clients, like prepayments on orders, retainers, or other client monies you are holding (which are called LIABILITIES).

Naming an account “Deposits Held”  or “Deposits” may be confusing; deposits from whom, to whom?

How to Account Deposits Payment Sent to Vendors

Sending a deposit to a vendor is generally a straightforward transaction or business; you merely write a cheque. However, the cheque is not an expense, it is called an asset. Hence, you post it to the ‘Vendor Deposits’ asset account to create the transaction or business journal seen on the next upcoming journal entry (the payee could be a utility company, the landlord, or any other vendor who requires a deposit).

Deposits Held by Others = $800. [Debit]

Bank Account = $800. [Credit]

 Returns Back of Vendor Deposits

Generally vendors return your deposit amount after a certain period of time. The simple method for returning a deposit is to send you a cheque, but from time to time the vendor may apply the deposit amount against the next bill.

If you receive a cheque, all you have to do is deposit the cheque into your bank account and post the transaction amount to the ’Deposits Held by Others’ asset account. This generate a transaction journal that is the reverse of the journal that recorded the cheque you wrote for the deposit.

  • Your bank account is debited [increased].
  • The asset account is credited [decreased].

If the vendor gives you a credit amount against the current expense (the cash amount due to the vendor) instead of sending you a cheque, you have to turn or exchange the asset into an expense. The method you use for this action is a journal entry, as seen given below:

  • Rent = $800. [Debit]
  • Deposits Held by Others = $800. [Credit]

If the payment amount of the deposit that is claimed to the next bill is less than the payment amount of the bill, you have to write a cheque for the open balance. The cheque is posted to the proper expense, not to the ‘Deposits Held by Others’ asset account. The total amount of the returned deposit and the cheque amount equals the expense that is posted for the month.

Tracking Prepaid Expenses Amount

If you pay in prepaid when you buy goods or services from a vendor, that funds is an asset. Generate a ‘Current Asset’ account give named ‘Prepaid Expenses’ to track these transactions.

When you create the cheque for the pay in advance expense, post it to the pay in advance Expenses account. This credits [decreases] the payment in the bank account and debits [increases] the paymant in the Prepaid Expenses account.

To exchange the asset into an expense when the vendor’s bill arrives (which may have a null balance if your deposit was funds in full), generate a journal entry that credits [decreases] the pay in advance Expenses account for the amount of your pay in advance and debits (increases) the proper Expense account. Now you have an expense amount on the books.

If there are extra charges on the vendor’s bill (such as the balance due or shipping costs,  if your prepayment was not for the entire total amount), pay those charges the way you generally pay bills, posting the amount to the proper expense account.

Allocating Anually Payments to Monthly Expenses

If you pay an yearly fee for a service that is provided monthly (such as technical support contracts,  insurance, security services etc.), you (or your company’s boss) may want you to track the expense amount on a monthly basis.

In this situation, when you write the single cheque for the yearly fee to the vendor, post it to the ‘Prepaid Expenses’ asset account, not to an expense account. You then post the expense by generating a journal entry each and every month same as to the one seen on the next journal entry—which is the monthly expense for an yearly premium of dollar 1,200. The journal entry minimised the ‘Prepaid Expenses’ asset account and increases the expense account.

Insurance = $100. [Debit]

Prepaid Expenses = $100. [Credit]



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