How do I record income if I’m paid before the work is completed?

Understanding the Core Question: What Does “Paid Before the Work Is Completed” Really Mean?

Getting paid before you finish the job is common in many industries. Contractors receive deposits. Freelancers request retainers. Agencies bill upfront. Subscription businesses collect money at the beginning of the month. Event planners take payments months before the event. Even product-based businesses may get preorders long before shipment.

The accounting question underneath all of these situations is the same: when should you recognize the income? In everyday language, “income” might feel like it happens when cash hits your account. But in accounting and tax practice, there are often different rules for when you record revenue (for your books) versus when you report taxable income (for your tax return). The right answer depends on your accounting method, your business structure, and the specific terms of what you promised to deliver.

This article walks through the practical “how” of recording income when you’re paid in advance, including what to do on your bookkeeping records, what accounts to use, and how different accounting methods handle the timing. It also covers common scenarios—deposits, retainers, milestone payments, subscriptions, gift cards, and preorders—plus the pitfalls that can lead to confusion or messy financial statements.

Why Timing Matters: Revenue Recognition vs. Cash Movement

When a client pays you early, two things happen at the same time: your cash increases, and you take on an obligation. That obligation is the promise to do the work or deliver the product later. Even if you feel like you “earned it” because you landed the client, from an accounting perspective you often haven’t completed the performance yet.

That is why many businesses treat advance payments as a liability at first. A liability isn’t always a bad thing—here it simply means you owe something: services, deliverables, or refunds if you fail to perform. As you complete the work, that liability decreases and revenue increases.

If you record everything as revenue the moment you’re paid, your financial statements can become misleading. One month might look unusually profitable just because you collected a lot of upfront payments, while the following month looks weak because you’re busy delivering work without collecting much new cash. A liability-based approach smooths revenue into the periods when you actually perform the work.

The Two Main Accounting Methods: Cash Basis and Accrual Basis

Before you decide how to record advance payments, you need to know which accounting method you use for your books. Many small businesses use cash basis because it’s simpler. Many larger businesses, and businesses with inventory or external reporting requirements, use accrual basis. Some businesses keep cash-basis books but still track deposits carefully for management reasons.

Cash Basis: Record Income When You Receive Cash (With Important Exceptions)

Under pure cash-basis bookkeeping, you generally record income when the money is received, even if the work isn’t completed. That means if you receive a deposit in January for a project you finish in March, January shows the income.

However, “cash basis” can still involve nuance depending on your jurisdiction and tax rules. For example, certain types of advance payments may be treated differently for tax purposes even if you prefer cash-basis bookkeeping. Some businesses keep their internal books on a modified cash basis—recording most transactions when cash moves, but using a liability account for customer deposits so they can see what they still owe clients.

Even if you’re cash basis for tax, tracking unearned amounts can be helpful. It helps you avoid spending money that’s needed to fund future work, and it provides a clear picture of obligations when you look at your financial position.

Accrual Basis: Record Revenue When You Earn It

Under accrual accounting, you record revenue when you earn it—meaning when you deliver the goods, perform the services, or otherwise satisfy the obligation to the customer. If you’re paid before you perform, the money is typically recorded first as a liability, often called “deferred revenue” or “unearned revenue.” Then, as you complete the work, you recognize revenue gradually or at milestones.

Accrual accounting is often the clearest way to match income to effort. If you’re building something over time, it can make sense to recognize revenue over the life of the project. If you deliver a product at a single point in time, you recognize revenue when the product ships or the service is delivered.

The Key Bookkeeping Concept: Deferred Revenue (Unearned Revenue)

When you get paid upfront and you haven’t earned it yet, the standard bookkeeping move (especially on accrual) is to record the payment as deferred revenue. Think of deferred revenue as “money received for work not yet done.” It sits on your balance sheet as a liability until you perform.

The most common account names include:

• Unearned Revenue

• Deferred Revenue

• Customer Deposits

• Advances from Customers

• Contract Liabilities

Which label you choose matters less than consistency and clarity. If you offer refundable deposits, “Customer Deposits” may communicate the nature better. If you sell subscriptions, “Deferred Revenue” is commonly used. If you’re doing contract work, “Contract Liabilities” might fit.

How to Record the Initial Payment (Accrual-Friendly Approach)

When the client pays you upfront, you record:

1) An increase in cash (or bank account).

2) An increase in deferred revenue (liability).

In double-entry terms, you debit cash and credit deferred revenue. If you’re using bookkeeping software, this often happens by creating a sales receipt or invoice payment that is mapped to a liability account instead of a revenue account.

Example: You receive £2,000 in January as an upfront payment for a design project you will deliver in February. On receipt:

• Cash increases by £2,000.

• Deferred revenue increases by £2,000.

No revenue is recognized yet (on accrual), because the work hasn’t been completed.

How to Recognize Revenue as Work Is Completed

As you complete the work, you “release” the deferred revenue into actual revenue. That means:

1) Decrease deferred revenue (liability goes down).

2) Increase revenue (income statement goes up).

In double-entry terms, you debit deferred revenue and credit revenue.

Continuing the example: In February, you complete the project. You recognize the £2,000 as revenue in February by reducing deferred revenue and increasing revenue.

That way, your January financials show cash increased but also show that you owe services, and your February financials show the revenue in the period you delivered the work.

Partial Completion: Recognizing Revenue Over Time

Many projects aren’t “all or nothing.” If you’re building a website, consulting over several months, or delivering a multi-step project, you might earn revenue as you go. Under accrual accounting, there are two common approaches:

Recognize Revenue at Milestones

This method recognizes revenue when a distinct deliverable is completed. For example, a contract might have milestones like “initial concept,” “first draft,” “final delivery,” or “phase 1 complete.” Each milestone corresponds to a portion of the total fee. When the milestone is delivered, you move that portion from deferred revenue to revenue.

This is often easiest if your contract terms clearly define the milestones and associated payments or values.

Recognize Revenue Based on Progress

This method recognizes revenue gradually based on the percentage of work completed. For example, if you estimate a project is 40% complete at month-end, you recognize 40% of the total contract revenue (to the extent you’ve been paid or are entitled to bill).

Progress-based revenue recognition can be more accurate, but it requires a consistent and defensible way to measure progress. Some businesses use labor hours, cost incurred, deliverables completed, or time elapsed—whatever best reflects performance.

Different Types of Upfront Payments (And How to Handle Each)

Not all “paid before completion” arrangements are the same. Here are common categories and the typical recording approach.

Deposits for Future Work

A deposit is usually a partial payment made to reserve time or start a project. Deposits can be refundable or non-refundable. The refundability can affect how you present and track it, but the basic accounting logic is similar: until you earn it, treat it as a liability.

If your deposit is non-refundable but you still haven’t delivered anything, many accrual approaches still treat it as deferred revenue until you perform. The “non-refundable” label may protect you contractually, but from an accounting viewpoint you generally don’t want to recognize revenue before satisfying your obligations.

Retainers

Retainer is a word that means different things in different industries, so you need to identify what your retainer actually is:

• A “true retainer” that reserves your availability, regardless of whether services are requested.

• An advance payment that will be applied against future services.

• A minimum monthly fee for ongoing access and work.

• A prepaid block of hours.

If the retainer is an advance against future work, it’s typically deferred revenue until you perform the work. If it’s a fee paid to secure availability, some businesses treat it as earned when the availability period occurs, which could mean revenue recognized over that period. A prepaid block of hours is usually recognized as revenue as hours are used.

Milestone Payments (Paid in Advance of Each Phase)

Sometimes clients pay a phase fee before the phase begins. In this case, you can defer each payment and recognize it when the phase is completed or as progress occurs within that phase.

Clear documentation helps: if your statement of work says “Phase 2: £5,000 due upfront, delivery expected in March,” then deferring and recognizing in March (or over March) is a clean match.

Subscriptions and Memberships

Subscriptions are a classic example of being paid before the work is “complete.” If a customer pays for a year of membership upfront, you typically recognize revenue over the membership period, not on day one. Each month, you release one month’s portion of the deferred revenue into revenue.

This method provides a much more realistic view of monthly performance and helps you understand recurring revenue trends.

Preorders for Products Not Yet Delivered

If customers pay for a product that hasn’t shipped, the payment is generally a liability until you deliver the product. Once the product ships (or transfers to the customer, depending on your delivery terms), you recognize the revenue.

If you have inventory, you’ll also record the cost of goods sold and reduce inventory at the time of delivery, aligning costs with the revenue.

Gift Cards and Vouchers

Gift cards are another form of “paid before completion.” When someone buys a gift card, you receive cash but you still owe goods or services. That’s typically deferred revenue until the card is redeemed. If a card expires or is never used, rules vary on when and whether you can recognize that as revenue. Operationally, it’s best to track outstanding gift cards carefully so you can see what remains owed.

What If You Invoice Upfront Rather Than Receiving Money Upfront?

Invoicing and getting paid are not the same thing. You might invoice upfront and get paid later, or you might get paid immediately without invoicing (for example, through an online checkout).

Under accrual accounting, an invoice can create accounts receivable. If the invoice is for work not yet performed, you may still treat the invoice as deferred revenue rather than immediate revenue. In other words, you can invoice and create a receivable (or record cash when paid), while still keeping the corresponding credit in a deferred revenue liability until the work is completed.

Under cash-basis bookkeeping, invoicing itself usually doesn’t create income until payment is received. But many businesses still use invoices to document what the customer owes and what the payment covers.

Practical Journal-Entry Examples You Can Copy Conceptually

These examples illustrate the logic behind the entries. You don’t need to manually journal every transaction if your software handles it, but understanding the flow helps you set your accounts correctly.

Example 1: Upfront Payment for a One-Time Service

You receive £1,200 upfront on January 10. You complete the service on February 5.

On January 10 (payment received):

• Increase bank/cash £1,200

• Increase deferred revenue £1,200

On February 5 (service completed):

• Decrease deferred revenue £1,200

• Increase service revenue £1,200

Example 2: Deposit and Final Payment

Total project fee is £5,000. Client pays a £2,000 deposit in January and the remaining £3,000 on completion in March. You deliver in March.

On deposit receipt in January:

• Cash up £2,000

• Deferred revenue up £2,000

On final payment receipt in March:

• Cash up £3,000

• Deferred revenue up £3,000

On delivery in March:

• Deferred revenue down £5,000

• Revenue up £5,000

Example 3: Annual Subscription Paid Upfront

Customer pays £600 on January 1 for 12 months of access.

On January 1:

• Cash up £600

• Deferred revenue up £600

Each month-end (January through December), recognize £50:

• Deferred revenue down £50

• Subscription revenue up £50

Example 4: Prepaid Hours Retainer

Client pays £2,500 for 25 hours at £100/hour. In month one, you deliver 8 hours; in month two, 10 hours; month three, 7 hours.

On receipt of payment:

• Cash up £2,500

• Deferred revenue up £2,500

After month one (8 hours):

• Deferred revenue down £800

• Revenue up £800

After month two (10 hours):

• Deferred revenue down £1,000

• Revenue up £1,000

After month three (7 hours):

• Deferred revenue down £700

• Revenue up £700

How This Shows Up in Your Financial Statements

When you use deferred revenue correctly, your financial statements become easier to interpret.

Balance Sheet Impact

When you receive money upfront, your cash increases, but your liabilities also increase. That keeps your equity from jumping prematurely. Your balance sheet reflects that you have cash in hand but also obligations to fulfill.

Profit and Loss Statement Impact

Revenue appears when you actually earn it. This means your profit and loss statement better reflects performance in each period. You can compare months more meaningfully, and you’re less likely to overestimate profitability during a period of heavy prepayments.

Cash Flow Statement Impact

Cash flow will still show the cash coming in when received. This is one reason it’s helpful to separate “cash health” from “profitability.” You can be cash-rich because of prepayments while still not having “earned” the revenue yet.

Common Mistakes When Recording Income Received in Advance

Even experienced business owners make predictable mistakes with advance payments. Avoiding these can save you from confusing reports and tax surprises.

Mistake 1: Recording All Prepayments as Revenue Immediately (When You’re on Accrual)

If you’re accrual basis for your books, treating advance payments as immediate income can inflate your revenue, distort margins, and make month-to-month analysis unreliable. It can also create a mismatch where you incur costs later with no revenue appearing then, making later months look artificially weak.

Mistake 2: Mixing Deposits Into Revenue Without Tracking What You Still Owe

Even if you’re cash basis for taxes, not tracking outstanding deposits can cause operational problems. You might spend money that needs to fund future work. You might also lose track of which clients have credit balances, leading to awkward conversations or accidental double-billing.

Mistake 3: Failing to Reconcile Deferred Revenue Regularly

Deferred revenue is only useful if it’s accurate. If you collect deposits but never “release” them into revenue when you deliver work, your revenue will be understated and your liabilities overstated. A good practice is to reconcile your deferred revenue account at least monthly by tying it to a list of open projects, unredeemed gift cards, or prepaid subscriptions.

Mistake 4: Confusing “Non-Refundable” With “Earned”

Non-refundable deposits can still represent an obligation. In many cases, the client paid to secure future performance, and until you provide that performance (or the relevant availability period passes), recognizing revenue may be premature on accrual books. Treat “non-refundable” as a contract term, not an automatic accounting conclusion.

Setting Up Your Chart of Accounts to Handle Advance Payments Cleanly

A simple chart of accounts setup can make advance-payment tracking easy. Consider including:

• A liability account: Deferred Revenue (or Customer Deposits)

• Revenue accounts: Service Revenue, Subscription Revenue, Product Sales, etc.

• If you need detail: sub-accounts for different revenue streams or different types of deferred revenue

The key is that customer prepayments should not be mixed into the same category as revenue until earned (if you are following accrual principles). If you want even more clarity, you can track deferred revenue by customer using your software’s customer balances or by creating separate tracking categories, classes, or projects.

Operational Best Practices: Make It Easy to Know What’s Earned

Accounting is much easier if your operations generate clear evidence of progress. Here are practical practices that reduce guesswork.

Use Clear Contracts or Statements of Work

Your contract should define what the client is paying for and when it is considered delivered. If there are milestones, state them. If the work is ongoing, define the service period. If it’s a subscription, define the term.

Track Delivery Dates and Milestones in One Place

If your bookkeeper has to dig through emails to figure out when something was delivered, revenue recognition will be inconsistent. Use a project management tool, a spreadsheet, or your invoicing system to record milestone completion dates.

Schedule Monthly Reviews

A simple monthly routine helps keep your books aligned:

• List all projects with deposits or prepayments.

• Confirm what was delivered this month.

• Move the earned portion from deferred revenue to revenue.

This routine prevents the deferred revenue account from becoming a “junk drawer” that grows without explanation.

Tax Considerations: Your Books and Your Tax Return May Differ

Many business owners are surprised to learn that their bookkeeping method and their tax reporting timing can differ. You might keep accrual books for good business insight but still report taxes on a cash basis (or vice versa, depending on rules and elections). That can create temporary differences in timing between book income and taxable income.

If you’re cash basis for tax, you might owe tax on money received upfront even if you haven’t delivered the work. If you’re accrual for tax, you may have more alignment between earning and recognition, but tax rules can still have special provisions for advance payments.

The most practical takeaway is this: record your transactions in a way that produces clear, truthful financial statements, and separately understand how your tax method treats the timing. If your tax timing differs, your accountant can help you adjust your tax reporting without wrecking your internal management reporting.

Special Situations That Deserve Extra Care

Some situations require more deliberate handling because they’re easy to misclassify.

Refundable Deposits and Potential Refunds

If there’s a meaningful chance you will need to refund the customer, treating the payment as a liability is especially important. You may even want to split your tracking: one portion that is a refundable deposit and another portion that is an advance payment for services. The clearer you are, the easier it is to manage refunds without accidentally reducing revenue that was never recognized.

Multi-Element Deliverables (Part Service, Part Product)

Imagine you sell a package that includes a setup fee, monthly support, and a physical deliverable. It may be appropriate to recognize different parts at different times. The setup might be earned upon completion of setup. The support is earned over time. The physical deliverable is earned on delivery. In these cases, you may allocate the total payment across the components and recognize each portion when earned.

Cancellation Rights and Chargebacks

If customers can cancel and you must refund unused portions, that supports deferring revenue and recognizing it over time. It also suggests you should keep clean records showing exactly what portion has been earned at any date, so you can compute refunds accurately and quickly.

How to Decide What’s “Earned” When the Work Is Subjective

Some work is easy to define as complete: the product shipped, the event occurred, the report was delivered. Other work is more subjective: consulting, advisory services, creative work with multiple revisions, or general “availability” agreements.

A useful way to think about it is to ask: what did the customer pay for, and what evidence would prove you delivered it? If they paid for a month of access, time passing is evidence. If they paid for 10 calls, calls completed is evidence. If they paid for a finished design, delivery of the final files is evidence. If they paid for progress toward a long-term build, progress metrics (hours, costs, or stages) can be evidence.

The more subjective the work, the more important it is to pick a consistent method and apply it the same way each month. Consistency makes your financials comparable and defensible.

A Simple Decision Framework You Can Use Today

If you want a quick way to decide how to record an advance payment, walk through these questions:

1) Have I delivered the goods or fully performed the service yet?

If no, treat it as deferred revenue (especially on accrual) or track it as a deposit (even if cash basis) so you know it’s not fully earned.

2) Is the work delivered over time (like a subscription or ongoing support)?

If yes, recognize revenue over the service period rather than all at once.

3) Are there clear milestones or deliverables?

If yes, recognize revenue when each milestone is completed.

4) Does the customer have a right to a refund for unused portions?

If yes, deferring revenue and recognizing it as earned reduces the risk of overstating revenue.

5) Can I clearly document what portion is earned at month-end?

If not, improve your documentation (project tracking, time logs, milestone sign-offs) so your revenue recognition becomes straightforward.

How to Keep It Simple Without Sacrificing Accuracy

You don’t need to build a complex accounting system to handle advance payments properly. Many small businesses succeed with a simple approach:

• Record all advance payments into one deferred revenue account.

• Once a month, review your open projects and subscriptions.

• Move the earned portion into revenue.

• Keep a supporting schedule (even a spreadsheet) listing each customer prepayment, what it covers, and how much remains unearned.

This provides clarity without turning bookkeeping into a full-time job.

Putting It All Together: A Realistic Example Across Multiple Months

Let’s say you run a marketing consultancy. On January 1, a client pays £3,000 upfront for three months of services (January, February, March). You also receive a separate £1,500 deposit on January 20 for a project deliverable due in February.

On January 1, you record £3,000 as deferred revenue. On January 20, you record £1,500 as deferred revenue. At the end of January, you’ve delivered one month of the three-month service agreement but haven’t delivered the February project deliverable yet.

End of January revenue recognition might look like:

• Recognize £1,000 (one-third of the £3,000) as revenue for January services.

• Keep the £1,500 deposit deferred because that deliverable isn’t completed.

At the end of February, you deliver the project and also complete the second month of services:

• Recognize another £1,000 for February services.

• Recognize the £1,500 deposit as revenue because the deliverable is complete.

At the end of March:

• Recognize the final £1,000 for March services.

Now your revenue aligns with the periods of work, your cash shows the timing of collections, and your deferred revenue account tells you what you still owe at any point.

When to Get Professional Help

Advance payments are routine, but certain situations justify professional guidance, especially if amounts are large or contracts are complex. Consider getting advice if:

• You have multi-year contracts or large upfront payments.

• You bundle products and services with different delivery timings.

• You have significant cancellation or refund obligations.

• You are switching accounting methods or preparing statements for lenders or investors.

• You operate across jurisdictions with different tax rules.

A qualified accountant can help you implement a consistent policy so your books stay clean and your tax filings are accurate.

Summary: The Clean Way to Record Income When You’re Paid Before Completion

When you’re paid before the work is completed, the most reliable approach—especially under accrual accounting—is to treat that payment as deferred revenue (a liability) until you’ve earned it by delivering the goods or services. Then, as you complete the work (either at a point in time, by milestones, or over a period), you move amounts from deferred revenue into revenue.

If you use cash-basis accounting, you may record income when you receive the cash, but it can still be wise to track customer deposits and unearned amounts so you understand your obligations and avoid confusion. Regardless of method, consistency, clear documentation, and a simple monthly review process will keep your records accurate and your financial statements meaningful.

In practical terms: receiving money early doesn’t automatically mean you’ve earned it. Recording it as deferred revenue until you deliver is the cleanest way to show both realities at once—you have the cash, and you still have work to do.