Why a deposit is a liability
When a customer pays a deposit, you owe them either the product or service, or their money back. That obligation is a liability, usually called customer deposits or unearned revenue. It becomes income only when you deliver or earn it.
Cash-basis taxpayers may treat money received differently for tax. Your reports for management can still show deposits separately. Ask your CPA about your specific situation.
Recording the deposit
Create a liability account such as customer deposits. When money arrives, debit the bank and credit that liability, tagged with the customer name. In many programs you record a payment or credit memo on the customer, which creates the same effect.
Do not create an invoice for the deposit amount and then another for the work unless your system handles the linking properly.
Applying the deposit
When the job is invoiced, issue the full invoice for the work. Then apply the deposit as a credit against it. Revenue is recognized for the whole amount, the liability is cleared, and the customer owes only the remaining balance.
For progress billing, apply deposits at the stages stated in the contract. Spell out in the agreement whether the deposit is applied to the final invoice or to the first one.
Refunds and cancellations
If a customer cancels, check the contract for what is refundable. A refundable deposit is returned by debiting the liability and crediting the bank. A non-refundable one, if the contract allows, may be recognized as income when you keep it. The treatment depends on the terms and the law, so ask an attorney or CPA for wording and treatment.
Document the reason, the date and the amount for each case.
Reviewing the balance
Run the liability account by customer every month. Each balance should match a live job or a planned delivery. Old balances with no activity need investigation: an unfinished job, a refund owed or a deposit applied to the wrong customer.
Keep the cash from deposits in mind during planning. It belongs to the work not yet done, so spending it elsewhere can cause trouble when the work comes due.
A simple example
A photographer takes a deposit to hold a wedding date. The deposit goes to a customer deposits liability. On the wedding day the full invoice is created, the deposit is applied against it, and the client pays the rest. Income is recognized for the whole fee at the time the service is delivered, and the deposit liability is cleared. If the couple cancels, the contract decides whether any of the deposit is returned, and the entry follows the contract.
Common questions
Is a retainer the same as a deposit?
Similar. A retainer is often a prepayment for future services, drawn down as work is done.
Do I owe sales tax on a deposit?
Rules vary by state and product. Check with the state tax agency or your CPA.
Can I deposit retainers in my operating account?
Some professions require separate trust accounts. Check any rules that apply to you.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.