Advance payment is a type of payment made ahead of its normal schedule, such as paying for a good or service before you actually receive it. Sellers sometimes require advance payments as protection against nonpayment or to cover their out-of-pocket costs for supplying the service or product.
There are many cases where advance payments are required. Consumers with bad credit may need to pay companies in advance, and insurance companies generally require an advance payment to extend coverage to the insured party.
Key Takeaways
- Advance payments are made before receiving a good or service.
- In many cases, advance payments protect the seller against nonpayment if the buyer fails to pay at the time of delivery.
- Companies record advance payments as assets on their balance sheets.
- A prepaid cell phone is a common example of an advance payment.
Understanding Advance Payments
Advance payments are amounts paid before a good or service is actually received. The balance that is owed, if any, is paid once delivery is made. These types of payments are in contrast to deferred payments. In these cases, goods or services are delivered first, and then paid for later. For example, an employee who is paid at the end of the month for that month’s work is receiving a deferred payment.
Advance payments are recorded as assets on a company’s balance sheet. As these assets are used, they get expended and recorded on the income statement for the period in which they are incurred.
Advance payments are commonly made in two situations. They can apply to a sum of money provided before a contractually agreed-upon due date, or they may be required before the receipt of the requested goods or services.
Advance Payment Guarantees
An advance payment guarantee serves as a form of insurance, assuring the buyer that should the seller fail to meet the agreed-upon obligation of goods or services, the advance payment amount will be refunded to the buyer. This protection allows the buyer to consider a contract void if the seller fails to perform, reaffirming the buyer’s rights to the initial funds paid. Governments also issue advance payments to taxpayers, like Social Security.
Special Considerations: Advance Payments to Suppliers
In the corporate world, companies often have to make advance payments to suppliers when their orders are large enough to be burdensome to the producer. This becomes especially significant if the buyer decides to back out of the deal before delivery.
Advance payments can assist producers who lack sufficient capital to buy the materials needed to fulfill a large order, as they can use part of the money to pay for the product they will be creating. It can also serve as assurance that a certain amount of revenue will be brought in by producing the large order. If a corporation needs to make an advance payment, it is recorded as a prepaid expense on the balance sheet under the accrual accounting method.
Examples of Advance Payments
There are many examples of advance payments in the real world. For instance, prepaid cell phones require payment for cell services that will be used by the customer one month in advance. If payment is not received in advance, the service will not be provided. The same applies to paying for upcoming rent or utilities before they are contractually due.
Another example involves eligible U.S. taxpayers who received advance payments through the Premium Tax Credit (PTC) offered under the Affordable Care Act (ACA). This financial assistance helps citizens, who meet household income requirements, pay for their health insurance. The money due to the taxpayer is paid to the insurance company in advance of the actual credit due date. The American Rescue Plan, signed by President Biden on March 11, 2021, made modifications to the ACA Premium Tax Credit to offer expanded eligibility through 2022.
Furthermore, consumers with bad credit might also need to provide creditors with advance payments before they can purchase goods or services.
Related Terms: Deferred Payments, Prepaid Expenses, Accrual Accounting, Insurance Premiums, Prepaid Cell Phones.
References
- Social Security Administration. “2187. Direct Field Office Payments”.
- Cornell Law School. “Advance”.
- Internal Revenue Service. “The Premium Tax Credit - the Basics”.
- Internal Revenue Service. “Premium Tax Credit: Claiming the Credit and Reconciling Advance Credit Payments”.
- U.S. Congress. “H.R. 1319”, Page 180.
- Consumer Financial Protection Bureau. “Fair Credit Reporting Act”, Page 6.
