Definition of Down Payment on a Contract
A down payment on a signed contract means a company has received money in advance of doing the work specified in the contract. As for the accounting, the company must record the money in its Cash account and a liability for the money received in advance of doing the work. (The contract without the money is a commitment, but is not recorded in the accounts as a liability.)
Example of a Down Payment on a Contract
Assume that TOPCO signs a contract to construct a special machine for one of its customers. The contract requires the customer to pay TOPCO $5,000 when the contract is signed and the remainder of $20,000 to be paid when TOPCO delivers the machine within 30 days of the signing.
When TOPCO receives the $5,000 down payment, it records the following:
- Debit to the current asset Cash for the $5,000 down payment received
- Credit the current liability Customer Deposits for $5,000
At the time TOPCO completes the special machine and receives the balance of $20,000, TOPCO will record the following entry:
- Debit the current liability Customer Deposits for $5,000 (to remove the liability)
- Debit the current asset Cash for $20,000
- Credit the income statement account Revenues from Machine Construction for $25,000
