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The Prepayment and Over Payment options on Customers really adds an unnecessary layer of complexity - and in my opinion one of Xero's worst features. Given that some might find it beneficial in my opinion its BS compared to other accounting products.
Idea: give me an option to use customer as 'open-item' or 'Balance forward' in Pastel terms. If it's a payment without an invoice - post it as credit on account, if it's an over payment on account, leave it as a credit. In other words just take payment from oldest invoices and leave credit or over payment which ever might apply - easy as that.
You should really look to products like QB and they way they handle customer payments, much much easier.

When the client is cash accounting, VAT should be recognised on overpayments. When suppliers and customers pay lump sums against outstanding balances, it's incorrect VAT treatment if they're not included in VAT returns even if they're not allocated to specific invoices.

Yes, please rename "Overpayment" to "Payment On Account"

Some customers pay partially for an entire statement, in advance, by mistake or a chunk for a number of invoices that often does not tally. This payment does not necessarily mean they overpaid. The issue for us arise when we send them statements. Customer reads the word "Overpayment" on their statement and quite often misunderstood despite writing the words 'Payment on Account' as reference.

It took me a long time and much frustrating searching before I discovered that the well understood term "payment on Account" was named "Overpayment" in Xero. While I understand that "overpayment" is the term used in New Zealand and Australia, isn't is possible to support international variations on the term? I log into Xero UK. Why can't the version of the software I use (which copes with specific UK functions such as our VAT setup) also cope with the concept of "Payment on Account"?

I totally agree. Overpayment is a rare thing in my world. We are having to post advance payments such as monthly standing order payments for accountancy fees and other advance payments neither of which are an overpayment. Accounts means accounting for something in an accountable way. Calling an action incorrectly is not accounting for something it is more likely to be misleading.

I wish the term overpayment would be renamed. When clients see overpayments it looks like I have made mistakes when it is not the case. It is usually called payment on account on other systems.

There are many occasions when payments are made in advance. Our accountants have instructed one of my clients to post their advance payment as an overpayment until the accounts are filed and the invoice is received. They have been told that they can't claim the VAT until the end of this process. Calling it an overpayment is both technically incorrect and very confusing for them. There should be an option for Overpayment as well as one called Prepayment. Both of these should be applicable to Spend Money as well as Receive Money for customers and suppliers. Both options should show on customer statements as a credit waiting to be allocated.

It is incorrect to post a payment on account calling it "overpayment", as in my opinion they are two different things. Sometimes we need to post the payment on the account unmatched, if for example the payment bounced back. That's not an overpayment. And we should then be able to match the bounced back payment (money received) directly to the payment on account (money spent) in order to leave the bill open. At the moment this is done manually posting to the suspense account, but surely there could be a feature which would automatically do the job letting us matching the payment on account to the bounced back money? But for sure it shouldn't be called overpayment in the first place.