Advance payments and work in progress: how to account for them

Anyone who works to order — construction, plant engineering, software, project consulting — reaches year-end with jobs started but not yet invoiced, and often with advance payments already collected from clients. How are they recognised on the balance sheet? Getting the treatment wrong means distorting the year’s profit: recognising revenue that has not yet been earned or, conversely, ignoring value already produced. The Code of Obligations sets the course; prudence does the rest.

What work in progress is

Work in progress on order consists of multi-year services, or services straddling more than one financial year, carried out for a client under a specific contract: a building under construction, a plant being assembled, a software project in development. At year-end part of the work is done but not yet delivered or invoiced. That value must be represented, otherwise costs already incurred would be left without the corresponding revenue.

It must be kept separate from advance payments, which are sums collected from the client before completion: they are not revenue, but prepayments. Until the service is rendered, the advance is a liability towards the client, not a profit.

The two logics of revenue recognition

There are two approaches to recognising contract revenue.

Completed contract: revenue is recognised only when the work is completed and delivered. Until then, work in progress remains recorded under assets at cost (or at the lower realisable value). This is the most prudent approach and the one most in line with the logic of the Code of Obligations.
Percentage of completion: revenue and the related profit are recognised progressively, based on the percentage of completion of the contract. It better reflects the economic reality of long projects, but it requires reliable estimates of progress and total cost.

The percentage-of-completion method anticipates profits not yet realised and must therefore be used with caution and only when the preconditions (a firm contract, progress and margin reliably estimable) are solid. Under the CO the baseline approach remains prudent.

How they are valued on the balance sheet

Work in progress is recorded, as a rule, at production cost: materials, direct labour and a reasonable share of indirect production costs. However, the principle of the lower of cost and realisable value applies: if the contract is heading for a loss, the expected loss must be recognised immediately, without waiting for the project to close. Foreseeable losses are anticipated; profits are not.

The role of advance payments

Advance payments collected are accounted for separately:

on collection, the cash inflow is recorded together with an advance payments liability towards the client;
as the service is rendered and invoiced, the advance is “turned” into revenue and the liability is reduced;
on the balance sheet, the advance received may be shown as a reduction of the value of work in progress or among liabilities, whichever presentation is clearer.

The key point: collecting is not earning. A large advance must not translate into profit until the work has actually been performed.

The VAT aspect

On the VAT side, care is needed: under the agreed consideration method (invoiced turnover), the tax is generally due at the moment of the invoice or the advance, even if the service is not yet complete. The advance collected can therefore give rise to the tax liability before the accounting recognition of the revenue. The VAT timing and the accounting timing must be coordinated to avoid mismatches.

Common mistakes

Treating advance payments as revenue of the year.
Failing to recognise the expected loss on contracts in difficulty.
Applying percentage of completion without reliable estimates, inflating profit.
Forgetting the VAT on advance payments collected.

In summary

Work in progress is recorded at cost, or at the lower realisable value.
Expected losses on the contract are recognised immediately.
Advance payments are liabilities towards the client, not revenue.
Always coordinate the accounting timing with the VAT timing.

How we help you

We set up the correct accounting for work in progress and contract advance payments, revenue recognition consistent with the Code of Obligations, and coordination with VAT. Account for your contracts properly.