Michael asked a question this week about how to post a deposit received from a customer into his Xero account, and whether or not he should account for VAT.

As with many accountancy questions – it depends!!

It depends on what the deposit is for. Deposits or prepayments will either be a part payment of goods and services or a security deposit just in case of future damages.

The accounting and VAT treatment is different for each.

Part payment of goods and services

If the deposit is for part payment of goods/services then VAT should be applied at the point of receipt.

You can account for this in a couple of different ways. This is how we might deal with a deposit in Xero:

1)  Raise an invoice for the deposit and a later invoice for the balancing payment of the purchase. Some customers would prefer to see a VAT invoice for their deposit – this means they can claim the purchase VAT back sooner in their own accounts.  You would need to remember to add a second invoice later for the balance of the payment on completion of the job. One way of achieving this is to approve one invoice for the deposit and save a second one for the balance to drafts awaiting issue at a later date.


2)  Post the receipt as a prepayment to the customer account.  Xero will account for VAT on the date of receipt of the payment. The transaction in Xero looks like a little like a sales invoice and will be given a sales invoice number – I would suggest adding PREPAYMENT to the end of the invoice number so it stands out against other invoices when you are looking at the customer account view. The VAT will be accounted for at the time of posting the deposit but you can offset the prepayment against the invoice that is raised later so VAT will only be accounted for once.

The prepayment is visible on the customer account until it is allocated to an invoice.
How do I account for VAT on deposits?

And is hidden as soon as it is allocated to an invoice.How do I account for VAT on deposits?

Xero Help Centre – Prepayments

Security deposit

You may ask your customers to pay a deposit when they hire goods from you. You don’t have to account for VAT if the deposit is either:

  • refunded in full to the customer when they return the goods safely
  • kept by you to compensate you for loss or damage

These can be posted to a balance sheet account – current assets – ‘customer deposits’ or they can be posted as an overpayment on a customer account that can be refunded later.


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