Customer deposits and retainers: how to record money received before the work

A deposit is not income yet

A kitchen designer takes $3,000 up front on a $10,000 job. A consultant takes a $5,000 retainer before starting. A caterer takes a deposit to hold a wedding date. In each case the money is in the bank, but the work is not done. If it fell through, the customer could ask for it back.

That is why a deposit is recorded as a liability, usually an account called Customer Deposits or Unearned Revenue: you owe the customer either the work or the money. It becomes income when you deliver and invoice. Booking it as income on the day it arrives overstates this month's profit and understates next month's, and on the accrual basis it puts income in the wrong year when a deposit lands in December for January work.

It is also not a payment on an invoice, because there is no invoice yet. Recording it against accounts receivable leaves a confusing credit balance on the customer and on the ageing report.

The entries, step by step

The designer's $10,000 job with a $3,000 deposit, no sales tax for now:

After step 4, the Customer Deposits account is back to zero for this customer, income is $10,000 in the month the work was billed, and the invoice is paid. Step 3 moves no cash; it just uses money you already hold. On a long job billed in stages, apply part of the deposit to each invoice, or all of it to the final one, as your contract says.

Check the Customer Deposits balance at every month-end. It should equal the deposits you are holding for work not yet invoiced, customer by customer. An old balance is usually a deposit someone forgot to apply.

Sales tax and GST/HST

Canada

The CRA's general rule is that GST/HST becomes payable on the earlier of the day you are paid and the day you issue the invoice. So a part payment of the price taken in advance is generally taxable when you receive it, not when you finish the work. An Ontario designer who takes $3,000 toward the price would charge 13% HST on it, $390, and report it in the period it was received.

A true deposit held as security, one you would refund if the customer kept their side of the deal, is treated differently: under the Excise Tax Act it is not consideration for the supply until you apply it to the price, so the tax arises when it is applied. The CRA's guidance on this (GST Memorandum 300-6-8) is old and the CRA says it has not been updated, so if your deposits are large or your contracts unusual, ask your accountant which kind yours are. The same timing question applies to PST and QST; see the GST/HST filing guide.

United States

Sales tax is set by each state, and states differ on whether tax is due when an advance payment is received or when the item is delivered or the service completed. Many services are not taxable at all. Check your state's rule before you decide when to charge it.

If tax is due when the money comes in, the simplest bookkeeping is to issue a deposit invoice for the advance with the tax on it, then a final invoice for the balance. If tax is due on the final invoice, the liability method above works as it is.

Refunds and forfeited deposits

A refund has no income effect. A kept deposit becomes income when the customer cancels. In Canada, the Excise Tax Act treats a forfeited deposit on a taxable supply as a payment that includes GST/HST, so part of the kept amount is tax you must report. Your contract should say clearly which deposits are refundable; it decides both the customer conversation and the tax.

Retainers held in trust

For most businesses, a retainer is just a deposit. For lawyers it is different: an advance fee is the client's money until it is earned. In the US, the American Bar Association's Model Rule 1.15(c), which many states have adopted, says advance fees and expenses go into a client trust account and are withdrawn only as fees are earned or expenses incurred. The ABA's Formal Opinion 505 (2023) adds that calling an advance "nonrefundable" does not change that. In Canada, each provincial law society sets the trust accounting rules.

The bookkeeping has three parts: a separate trust bank account, a ledger of what each client holds, and a liability equal to the total. When you bill earned fees, you move that amount from trust to the operating account and record it as payment of the invoice. The trust bank balance, the total of the client ledgers and the liability must always agree. That three-way check is what auditors from the bar look for.

In AcboBooks

The Customer Deposits screen records a deposit or retainer into the bank or Undeposited Funds and holds it in the Customer Deposits liability, showing what each customer has on deposit. When you invoice, you apply the deposit to the invoice; it will not let you apply more than the customer holds or more than the invoice is open for. The deposit itself carries no tax, so if your tax is due on receipt, use a deposit invoice instead. There is no refund button on the deposits screen; a deposit returned in full can be voided.

For law firms, Trust Accounting keeps a trust bank account and a client trust liability with a balance per client, refuses to disburse more than a client holds, and runs the three-way check. Moving earned fees to the operating account and paying the invoice is a separate entry. See AcboBooks for professional services.