Advance payment to suppliers, how is it accounted for?

What is an advance payment to suppliers?

The advance payment to suppliers consists, simply, in adelaying payment of the invoice for an order (of a good or service) requested by a company from its supplier. This formula is quite common among the self-employed and small businesses as they do not have enough power to negotiate other, perhaps more advantageous, payment arrangements with their suppliers, which would allow them to reduce daily expenses generated by its activity.

Advance payment for a future order is not an unusual or harmful practice, but we do have to know some details Regarding this form of advance payment for fertiliser, some accounting details that allow us to correctly record this expense in the corresponding accounting section according to the General Chart of Accounts.

Features of advance payments to suppliers

It notes, then, the main features of the advance payment to suppliers:

• Advance payments to suppliers can be in whole or in part.
• If payment of the order in advance is in full, we will pay the supplier the TOTAL AMOUNT of the corresponding invoice including input VAT.
• If we negotiate well or have been working with the same company for a long time, our supplier may allow us to pay only in advance a part of the final bill. In this case, the amount we pay in advance will be deducted from the final invoice.
• In both cases (full or partial advance payment to suppliers), the invoices for the advance payment will include VAT.
• The advance we are making is part of the assets from our company and must be registered as such in our accounting records. According to the General Accounting Plan, the credit for the advance payment will be recorded in the account 407. The moment we receive the goods for which we have paid in advance, we will move that amount from account 407 to the account Six hundred.

Advance payments to suppliers in the General Chart of Accounts

SMEs that do not have in-house or external advisors to take care of accounting often face problems when it comes to to record the advance payment to suppliers in its chart of accounts or PGC. Let's try to clarify these kinds of issues in the simplest way possible by looking at How are advances to suppliers accounted for on the company's balance sheet:

Here's how prepayments to suppliers are accounted for and what happens with the VAT: **Accounting for Prepayments to Suppliers:** When you make a prepayment to a supplier for goods or services you haven't yet received, you are essentially giving them an advance. This prepayment is recorded as an asset on your balance sheet. The accounting entry typically looks like this: * **Debit:** Prepayments to Suppliers (or a similar asset account) - This increases your assets. * **Credit:** Bank Account (or Cash) - This decreases your cash or bank balance. **What Happens with the VAT:** The treatment of VAT on prepayments depends on your jurisdiction's VAT rules. However, generally, you can reclaim the VAT on a prepayment *if* you have received a valid VAT invoice from the supplier and have made the payment. **Important Considerations:** * **VAT Invoice:** The crucial element is receiving a valid VAT invoice from the supplier. This invoice must contain all the required VAT elements (supplier's details, customer's details, date, description of goods/services, VAT amount, VAT rate, etc.). Without a valid VAT invoice, you cannot reclaim the VAT at this stage, even if you've paid. * **When VAT can be reclaimed:** You can typically reclaim the VAT on the prepayment once you have a valid VAT invoice and have made the payment. * **When goods/services are received:** When the goods or services are eventually delivered and you receive the final invoice, you will adjust your accounting entries. * The prepayment made will be derecognised (credited). * The expense or asset (depending on the nature of the goods/services) will be recognised (debited). * The VAT shown on the final invoice will be accounted for. If you have already reclaimed VAT on the prepayment, you will need to ensure the VAT on the final invoice is handled correctly to avoid double-counting or incorrect claims. Often, the final invoice will show the net amount after deducting the prepayment, and the VAT will be calculated on that net amount. If the VAT on the prepayment was reclaimed, then when the final invoice is received, the VAT needs to be adjusted. **Example Scenario:** Let's say you pay a £1,200 deposit for a piece of equipment, which includes £200 VAT. 1. **Making the Prepayment:** * Debit: Prepayments to Suppliers - £1,000 (Cost of equipment) * Debit: VAT Paid on Prepayments - £200 (VAT you can reclaim) * Credit: Bank Account - £1,200 2. **Receiving the Equipment and Final Invoice:** * The supplier might issue a final invoice for the remaining amount. Let's assume the total cost of the equipment was £5,000, and the deposit was £1,200. The final invoice might be for £3,800 plus VAT on the remaining £4,000 (£800). * Your accounting entries would then involve: * Recognising the full cost of the asset (£5,000). * Accounting for the full VAT (£1,000). * Removing the prepayment from your books. The exact accounting treatment and VAT reclaim process can vary slightly depending on the specific VAT legislation in your country and the nature of the transaction. It's always advisable to consult with your accountant or a tax professional to ensure compliance.

De acordo com o Plano Geral de Contabilidade, a conta que temos de utilizar para registar este adiantamento a fornecedores é a 407, within subgroup number 57 and with the heading entitled “Stocks”. And what about the VAT on advances to suppliers?

It's not a complex issue at all. All you need to do is remember that you have to register the Input VAT of this advance payment. This tax is booked in the account 472 of the PGC.

The accounting entry for an advance to suppliers: practical example

A practical exampleImagine you have a small carpentry business and your timber supplier is demanding full upfront payment for your next order, which amounts to €1000 plus 21% % VAT. You make the advance payment for the invoice (total amount + VAT) by depositing the money into the banking institution your timber supplier.

Against this background, the accounting entry The following would be the recording of the advance order operation:

A full summary The entry in our accounting books would be as follows:

As you can see, understanding and correctly recording this accounting figure, which is the advance to suppliers It's not as complicated as it might seem at first glance. Regardless, our advice for SMEs and entrepreneurs is always the same: to avoid accounting problems, it's best to rely on the services of a good internal or external advisor or use a simple accounting software that allows you to automate this type of task.