How to Account for Customer Deposits
How a Small Business Owner should account for client deposits commonly known as down payment. This article explains important concepts business owners need to know about recording client deposits, charging HST/GST, and whether to treat such fees as income or not.
You may be wondering if you should charge sales tax on client’s deposits and whether this money should be considered revenue.
Meet Pam.
Pam is a talented interior designer who runs her interior design firm in Downtown Toronto. Lately, her business has been growing, and she has started charging customers deposits before starting a project. Pam does her bookkeeping but is not sure how to record the deposits in QuickBooks, the accounting software she uses for her bookkeeping.
Throughout our discussion, we will use Pam’s business and her DIY accounting journey to explain how to record client deposits.
Retainers or Client Deposits are not considered Income.
Client Deposits are not considered Income. These monies represent your business obligation to provide services to a client regarding the completion of a stage in the project or fulfilling the work as a whole.
From a business perspective, Retainers/Client Deposits secure a project/client engagement or commitment to work with your Interior Designer or Architecture Firm. The purpose of using Client Deposits as a business practice is to ensure that your business does not carry the financial burden of starting a lengthy project -hiring contractors and sourcing billable goods if things fall through with the client. Client deposits definitely help improve your businesses' cash flow but should not be recorded as income in your Profit and loss statement!
Should I charge GST/HST on customer deposits?
Just like Pam, many interior designers and architects do not understand how these should be handled in their profit and loss accounts. For one, Retainers/Client Deposits do not carry GST/HST - sales tax applicable in Ontario for services/goods delivered to Ontario clients.
As mentioned earlier, Retainers/Client Deposits represent an obligation to provide services - services that you haven't been able to fulfill yet because the said project will take let’s say 3-12 months to complete. Given the nature of the Retainers/Client Deposits sales tax as such is not applicable.
How Should I Account for Customer Deposits?
Pam, our small business owner will not be able to record this money as a deposit until she has delivered the service to the client.
From an accounting point of view, below is a step-by-step process to account for customer deposits from when it’s received until revenue recognition:
Record as Liability in the Balance Sheet
Once the service is delivered, treat this money as a sale (recognize revenue) either the whole amount for short-term projects or using the percentage-of-completion method by debiting Revenue (Profit & Loss) and Crediting Liability (Balance Sheet).