A damage or security deposit can be either an asset or a liability, depending whether you're the one paying it or the one receiving it. You'll record it accordingly in your books, differentiating between those that will be repaid in a year or less and those that will be repaid in over a year.
Paying or collecting damage deposits is a common business activity, especially if you're in real estate management. How you classify them on your balance sheet depends on two factors: Whether you paid or received the deposit, and whether it will be repaid within a year.
TL;DR (Too Long; Didn't Read)
If the security deposit will be returned within one year, the payer records it as a current asset and the recipient records it as a current liability. For long-term deposits, report the payment as a long-term asset and long-term liability respectively.
Deposits as Assets
When a business places a security deposit – that is, it gives someone else money to hold against possible future charges – the deposit is listed as an asset on its balance sheet. It might be entered as something like "Security Deposits Receivable." Say the company placed a $1,000 security deposit when it rented a piece of equipment. Although that money is not in the company's hands, it still expects to get the money back when it returns the equipment. The deposit is therefore an item with future economic value to the company, the accounting definition of an asset.
Deposits as Liabilities
When a company collects a security deposit from a customer, the amount appears on its balance sheet as a liability. It might be listed as "Security Deposits Refundable" or something similar. Imagine the business collected a $1,000 security deposit from a customer who rented equipment. Although the company now has an additional $1,000 in its bank account, it doesn't really own that money outright. Those funds are likely be returned to the customer eventually. The deposit therefore represents a future financial obligation, the accounting definition of a liability.
Accounting Depends on the Repayment Term
If the deposit will be repaid within a year, it should be classified as a current asset or a current liability on the balance sheet, depending on whether the company paid or collected it. If the deposit won't be repaid for more than a year, it should be recorded as a long-term asset or long-term liability based on the same criteria.
Entries at Collection Time
When it comes time for a company to get a security deposit back or to refund it to a customer, the balance sheet accounting is fairly simple. Say the deposit in question is $1,000. When the deposit is an asset the company collects its $1,000 and adds it to its cash balance, then erases the $1,000 deposit asset. The total value of assets stays the same, so the balance sheet remains balanced. When the deposit is a liability, the company takes $1,000 out of cash to give back to the customer and erases the $1,000 liability. Assets and liabilities have each decreased by $1,000, so the sheet is still balanced.
If a security deposit is non-refundable, the company doesn't carry it on the balance sheet at all. The company that pays such a deposit would simply record it as an expense, while the company that receives it would book it as revenue. The same holds true when deposits are only partially refunded because of damage or some other reason. The non-refunded portion is an expense for the party that placed the deposit and revenue for the party that collected it.