Why are deposits and prepayment classified as liabilities in accounting?
Quick tour
What is a liability?
A liability is money the company holds temporarily and must repay or fulfill an obligation for in the future. These amounts are not true income; they represent obligations to refund or deliver services later.
Why are deposits liabilities?
When you collect a tenant or customer deposit, you’re holding it temporarily and may need to refund it later.
- If the lease ends with no damage, refund in full.
- If there’s damage, part may be deducted and the rest refunded.
Therefore, deposits are not income and should be recorded as liabilities.
✅ A deposit represents a responsibility to your customer.
Why is prepayment a liability?
Prepayment means you’ve received payment, but the service or goods are not yet delivered.
- For example, a tenant prepays 3 months of rent,
- you must deliver service over time and recognize revenue monthly.
Until service is completed, it remains a liability, not revenue you can recognize immediately.
✅ Prepayment represents your commitment to deliver service in the future.
Summary and reminders
| Account | Reason | Liability rationale |
|---|---|---|
| Deposit | Received but may need to be refunded | Obligation to refund customers |
| Prepayment | Received but service incomplete | Obligation to perform for customers |
✅ Record deposits and prepayment correctly so your financials reflect true obligations and income.