Unearned revenue definition, explanation, journal entries, examples

Unearned revenue is a liability account which its normal balance is on the credit side. The amount of unearned revenue in this journal entry represents the obligation that the company has yet to perform. An annual subscription for software licenses is an unearned revenue example.

Classic examples include rent payments made in advance, prepaid insurance, legal retainers, airline tickets, prepayment for newspaper subscriptions, and annual prepayment for the use of software. Once the company makes a sale against the advance, it must reduce the unearned revenues account balance. On the other side, the company must recognize revenue for the same amount.

Furthermore, it is also important to note that the current liability is recorded in the form of unearned revenue.
You can also use it to sort and analyze revenue received by criteria or automate amortization schedules.
After a month, ABC Co. sells $10,000 worth of goods to XYZ Co. against the amount received in advance.

The airline uses this unearned revenue to put toward company costs to fuel the airplane, perform maintenance and provide food, complimentary blankets and other items for passengers. The credit and debit are the same amount, as is standard in double-entry bookkeeping. Thanks to the recent adoption of Accounting Standards ASC 606, revenue recognition rules are now more uniform (where they used to be industry-specific). Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. The company can make the unearned revenue journal entry by debiting the cash account and crediting the unearned revenue account.

Journal entry required to recognize revenue at the end of each match:

You will, therefore, need to make two double-entries in your business’s records when it comes to unearned revenue, once when it is received, and again when it is earned. Every month, once James receives his mystery boxes, Beeker’s will remove $40 from unearned revenue and convert it to revenue instead, as James is now in possession of the goods he purchased. One of these principles relates to revenue recognition and states that revenue should be recorded when it is earned, rather than when cash is received. The most common type of unearned revenue is revenue derived from interest and dividends. Most people are involved in some investment, be it debt or capital. If, for example, a person invests in a dividend-paying company such as Disney, they are likely to receive a dividend payout every quarter.

What are unearned revenues?

You can only recognize unearned revenue in financial accounting after delivering a service or product and receiving payment.
Deferred expenses, or prepaid expenses, are payments that you make in advance, for services such as insurance coverage – you pay in advance for a cost you have yet to incur.
Firstly, the company debits the cash account and credits the unearned revenue account when the payment is received.
Since this is a liability from the standpoint of the company, it always has a credit balance.
At this point, you may be wondering how to calculate unearned revenue correctly.

Any business that takes upfront or prepayments before delivering products and services to customers has unearned revenue, which is often also called deferred revenue. If you don’t enter revenue received in the same accounting period that expenses were paid, this also violates the standard accounting principles. Unearned revenue is recorded on a company’s balance sheet under short-term liabilities, unless the products and services will be delivered a year or more after the prepayment date.

Since they overlap perfectly, you can debit the cash journal and credit the revenue journal. In this situation, unearned means you have received money from a customer, but you what kind of account is unearned revenue still owe them your services. Then, once the order or service is completed, an adjusting entry is made which debits Unearned Revenue and credits Service Revenue (or Sales Revenue). In accrual accounting, businesses must comply with several accounting principles that dictate when bookkeeping is done. Earned income A 15-year-old who works after school, for instance, and earns less than $1,100 would owe nothing in taxes. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Is Unearned Revenue a Liability?

On a balance sheet, the “assets” side must always equal the “equity plus liabilities” side. Hence, you record prepaid revenue as an equal decrease in unearned revenue (liability account) and increase in revenue (asset account). Once the business actually provides the goods or services, an adjusting entry is made.

Until 1984, in the UK, it was believed that it is an investment revenue because it is more permanent than earned revenue. Currently, earned and unearned revenue balance sheet is taxed in the UK at a flat rate. Because commitments are met within a year, unearned revenues are generally called short-term liabilities. When considering a solution that will take more time than a year to deliver, individuals inquiring about “is unearned revenue a burden in the long run” may be proven true. Unearned revenue should generally be documented as a long-term responsibility in these situations.

Unearned revenue on a company’s balance sheet is generally treated as a current liability and is expected to be subsequently charged to income during the relevant reporting period. Under the accrual basis of accounting, revenue should only be recognized when it is earned, not when the payment is received. Likewise, the unearned revenue is a liability that the company records for the money that it receives in advance.

Customer commitment

When you receive unearned revenue, you will record it on your business balance sheet first and then make the journal entry. First, you will debit prepaid revenue under current liabilities or the specific unearned revenue account type. Later, you will make the necessary adjusting journal entries once you recognize part of or the entire prepaid revenue amount. For example, a contractor quotes a client $1000 to retile a shower.

You can often find yourself receiving money long before you provide agreed-upon services or, conversely, providing services and then waiting for payment. To learn more about the different accounts in financial accounting and how to record them, head over to our chart of accounts guide. Subsequently, when a company makes a sale against the advance amount, it can remove the balance from liabilities and record the sale. Baremetrics is a business metrics tool that provides 26 metrics about your business, such as MRR, ARR, LTV, total customers, and more. The cash flow statement shows what money flows into or out of the company.

Is unearned revenue debit or credit?

The second type of unearned revenue – the so-called “random” money, the receipt of which depends on chance or luck. Of course, this group will include money for a successful bet, winning at the casino, and so on. The actions of the players in assessing the current situation, of course, can not be called work. Since this is a liability from the standpoint of the company, it always has a credit balance. This is because the company has received the amount, but has not yet earned the amount. Earned revenue means you have provided the goods or services and therefore have met your obligations in the purchase contract.

It can be thought of as a “prepayment” for goods or services that a person or company is expected to supply to the purchaser at a later date. When the company has fulfilled its obligations and earned the revenue, it should be recognized as revenue on the income statement. The amount recognized should be equal to the portion of the unearned revenue that has been earned during the reporting period.

Securities and Exchange Commission (SEC) that a public company must meet to recognize revenue. As we previously mentioned, unearned revenue is an obligation that the business is yet to settle. That’s exactly what we will be answering in this guide, along with everything else you need to know about unearned revenue in accounting. Most unearned sources of revenue are not taxed on wages, and all sources of unearned revenue are not taxed on employment, such as Social security and Medicare.

Let’s take a look at the lifecycle of one $5,000 advanced payment. Also, the United States Securities and Exchange Commission has reporting requirements for businesses that are specific to revenue recognition. Revenue recognition is a generally accepted accounting principle that dictates how revenue is accounted for. In conclusion, unearned revenue refers to the income a company receives before delivering goods or services to the customer. It represents a liability on the company’s balance sheet as the obligation to fulfill the promised goods or services still exists. Unearned revenue is initially recorded as a liability and then recognized as revenue when the goods or services are provided.