Customer Deposits

Customer deposits refer to the money received by a company before providing the product or service to the customer. It is also known as unearned revenue or prepaid income. In a balance sheet, customer deposit appears on the liability side as current liabilities.

Customer deposits are usually created when the company wants the customer to deposit a certain percentage of the price of the product or service to be deposited with them when the order is placed. The customer deposits are opened when a contract or an agreement is signed by the way company and the customer. This deposit may or may not be refundable depending upon the purpose of that deposit.

 Let us take an example. Company A agrees to produce expensive machinery for one of its customers. Company A requires the customer to pay Rs.50, 000 in advance. Company A begins to design and construct the machinery. The payment of Rs.50, 000 is made in Dec ’09 and the machinery must be delivered in June ’10. In Dec ’09 the company will debit cash for Rs.50, 000 and credit customer deposits account which is a current liability account.

There are various reasons as to why a company may want to collect customer deposits. Firstly, a company is dealing with that customer for the first time. Secondly, the product or service ordered is to be customized and the deposited amount stand as an assurance for the company, that the buyer will buy the product once completed. Thirdly, the company would seek to protect itself from credit risks. Lastly, id the company has to incur substantial up-front costs and would want the customer to finance a part of the cost

Questions:

• What are customer deposits? Explain with an example.
• What the reasons for a company to create customer deposits?