NIF C-5 «Advance Payments» regulates the accounting for advance payments and their recognition in the financial statements. Key points are summarized below:
Definition and Recognition:
Advance payments are disbursements made by an entity to receive goods or services in the future. These payments are initially recognized as assets on the balance sheet until the corresponding good or service is received.
Initial Measurement:
Prepayments are recorded at cost paid, which includes the amount disbursed and any directly attributable additional costs.
Recognition of Expense or Asset:
Advance payments are recognized as expenses in the income statement as the good or service is benefited. However, if the advance payment corresponds to the acquisition of fixed assets, such as property, plant and equipment, or inventories, it is transferred to the corresponding accounts (for example, Property, Plant and Equipment either Inventories) once the good or service has been received.
Amortization:
Advance payments are amortized systematically over the period in which they are received, using a method that reflects the pattern of consumption of future benefits. In the case of fixed assets and inventories, costs are allocated according to their nature and are recognized according to their use or consumption.
Presentation:
On the balance sheet, prepayments are presented as current or non-current assets, depending on the period in which they are expected to be consumed. Advances for fixed assets are classified as part of current assets. Property, Plant and Equipment and advances for inventories are presented in Inventories.
Revelation:
The nature of the advance payments, their amount and the period over which the benefits are expected to be consumed must be disclosed in the notes to the financial statements.
NIF C-5 ensures that advance payments are accounted for in a manner that faithfully reflects the financial position of the entity, aligning the recognition of expenses and assets with the moment in which the benefit is received.
Example: Advance Payment of Insurance
Situation: A company pays $12,000 for an insurance policy that covers a full year, beginning on January 1.
Advance Payment Record:
The company records the down payment as an asset. Since the insurance covers 12 months, it is considered a prepayment. As shown below:
Debit: Advance Expenses (Active) $12,000
Credit: Cash/Banks (Active) $12,000
Expense Recognition:
Each month, the company must recognize a portion of the prepayment as an insurance expense.The monthly expense is $1,000 ($12,000 divided by 12 months).
Accounting entry at the end of each month:
- Debit: Insurance Expense $1,000
- Credit: Advance Expenses $1,000
Presentation in the Financial Statements:
Balance sheet: As of January 31, the balance in the category of Advance Expenses will be $11,000 ($12,000 less $1,000 already amortized).
Statement of income: An insurance expense of $1,000 will be reflected for the month of January.
Notes to the Financial Statements:
- The company must disclose that it has a balance of $11,000 in Advance Expenses related to insurance, which will be amortized throughout the year.
This process ensures that the insurance expense is recognized in the period in which the benefit is received, rather than recording the entire expense at the time of payment.
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