Advance Payment

What Is an Advance Payment?

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.
Advance payments are sometimes required by sellers as protection against
nonpayment, or to cover the seller's out-of-pocket costs for supplying the service
or product.

There are many cases where advance payments are required. Consumers
with bad credit may be required to pay companies in advance,
and insurance companies generally require an advance payment in order 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
in case the buyer doesn't come and pay at the time of delivery.
 Companies record advance payments as assets on their balance sheets.
 A prepaid cell phone is an 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—or payments in arrears.
In these cases, goods or services are delivered first, then paid for later. For
example, an employee who is paid at the end of each month for that month's
work would be receiving a deferred payment.

Advance payments are recorded as assets on a company's balance sheet. As

these assets are used, they are expended and recorded on the income
statement for the period in which they are incurred.

Advance payments are generally made in two situations. They can be applied 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 is especially true if the buyer decides to back out of the deal before delivery.

Advance payments can assist producers who do not have enough capital to buy
the materials 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 be used as an assurance that a
certain amount of revenue will be brought in by producing the large order. If a
corporation is required 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. Take prepaid
cell phones, for example. Service providers require payment for cell services that
will be used by the customer one month in advance. If the advance payment is
not received, the service will not be provided. The same applies to payments for
upcoming rent or utilities before they are contractually due.

Another example applies to eligible U.S. taxpayers who received advance

payments through the Premium Tax Credit (PTC) offered as part of
the Affordable Care Act (ACA). The financial assistance helps citizens, that meet
household income requirements, pay for their health insurance.1 The money due
to the taxpayer is paid to the insurance company in advance of the actual due
date for the credit.

 
The American Rescue Plan, signed by President Biden on March 11, 2021,
made some changes to the ACA Premium Tax Credit. All taxpayers with
insurance bought on the Marketplace are now eligible for this credit in 2021 and
2022; previously, filers were ineligible if their income exceeded 400% of the
federal poverty line.2

Consumers with bad credit may also be required to provide creditors with
advance payments before they can purchase goods or services.