Advance paid

What it means

An advance paid is a payment a company makes to a supplier before the goods or services are delivered. For accounting purposes it is not an expense but a receivable from the supplier, which becomes an expense or an asset only after delivery and final invoicing.

Short-term advances for goods, materials and services are recorded on account 314. Advances for fixed assets are shown separately on accounts 051 and 052 and, after delivery, transferred into the acquisition cost of the asset or first into assets under construction.

Its counterpart is the advance received on the supplier’s side. For both parties it is important that the advance is clearly linked to a specific contract or order so that it can later be offset against the final invoice.

How it works in practice

When paying against a pro forma invoice, we record only the payment as an advance, because a pro forma invoice is not a tax document. If the supplier, as a VAT payer, issues an invoice for the payment received, the customer can deduct the VAT in the period of payment.

On settlement the supplier issues a final invoice deducting the advance received, including VAT. We check that amounts and rates agree and offset the advance on account 314 against the liability from the final invoice. Unsettled advances at year end are broken down by supplier.

On long-term projects, such as construction or a custom-built machine, we track advances against contractual milestones. This helps check that payments match the actual progress of work and protects the company from paying more than it has received.

What to watch out for

An advance is a risk. If the supplier fails to perform or goes bankrupt, the company may lose the money paid. Where there are doubts about a supplier we create an impairment allowance, and for larger amounts we recommend asking for a bank guarantee for repayment of the advance.

Long-standing unsettled advances on account 314 usually point to an error: the final invoice was posted without offsetting the advance, or the advance was paid twice. In a VAT audit there is also a risk that input VAT was deducted twice, on the advance and on the final invoice.