Definition of Unearned Revenue in Accounting

Here’s how to account for unearned revenues. (It’s easy!)

If it is a monthly publication, as each periodical is delivered, the liability or unearned revenue is reduced by $100 ($1,200 divided by 12 months) while revenue is increased by the same amount. Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered. What is the difference between deferred revenue and unearned revenue?

This concept also applies for customers who put down deposits on sales. Deferred or unearned revenue is an important accounting concept, as it helps to ensure that the assets and liabilities on a balance sheet are accurately reported. It makes perfectly clear to shareholders and other involved parties that the company still has outstanding obligations before all of its revenue can be considered assets. Under this method when unearned sales revenue is received by the business, the whole amount received is recorded under an Income account and proportionately adjusted as the goods or service is delivered by the business over the period of time as goods or service is provided. Unearned revenue is the number of advance payments which the company has received for the goods or services which are still pending for the delivery and includes transactions like Amount received for the goods delivery of which is to be made on the future date etc.

Another example of unearned revenue is rent that a landlord collects in advance. To illustrate how accounts are adjusted for unearned revenue, assume that on June 15, a company receives $25,000 to provide technical support services to one of its customers.

At the end of the year on 31.03.2019, Deferred Revenue, a liability will cease to exist and all revenue will be recognized in the Income Statement of ABC Limited. When a company receives cash for the goods or services that it will provide in future; it leads to an increase in Cash Balance of the company, since the goods or service is to be provided in future, the Unearned Income is shown as a Liability in the Unearned Revenue Balance Sheet of the company which resulted in proportional increase on both sides of the Unearned Revenue Balance Sheet (Asset and Liabilities). Let us now look at how Unearned revenue accounting works. In the hotel business we earn income or revenue (the same thing) when we deliver service. In my workshops we do a piece on the difference between the two types of income.

In this case rent is due for the entire year on January 15th. When a check for the full years rent is received, it creates a problem; the income has not yet been earned. Therefore rent is unearned income and must be treated as a liability until we earn it.

The contractor debits the cash account $500 and credits the Accounting and finance account $500. Later, the contractor finishes half the job. He makes an adjusting entry where he debits the unearned revenue account $500 and credits the service revenues account $500. A similar situation occurs if cash is received from a customer in advance of the services being provided. This is more fully explained in our revenue received in advance journal entry example.

However, the company’s fiscal year ends on May 31. So, the company using accrual accounting adds only five months’ worth (5/12) of the fee to its revenues in profit and loss for the fiscal year the fee was received. The rest is added to deferred income (liability) on the balance sheet for that year.

From this point on, each month 1/12 of the value of the unearned rent received in January will be moved from the liability account to the rent revenue account. This process is a great example of the matching principle and the conservatism principle. With the advance deposit example, the income is not earned until the guest actually arrives.

• At the end of the year on 31.03.2019, Deferred Revenue, a liability will cease to exist and all revenue will be recognized in the Income Statement of ABC Limited.
• Knowing the difference is essential to understanding a company’s overall financial situation.
• It is important to understand that while analyzing a company, Unearned Sales Revenue should be taken into consideration as it is an indication of the growth visibility of the business.
• The company receives an Annual subscription of Rs 12000 from one of its clients on 31.03.2018 for the next year.
• Higher Unearned income highlights the strong order inflow for the company and also results in good liquidity for the business as a whole.
• Here is an example journal entry.

In the meantime, I closed the books for the last accounting year (all bookkeeping done, tax declared and tax bill received, and tax for the year added), which now leaves me in a head scratching situation for how to move the correct amount of income from unearned revenue to income. Unearned revenue is reported on a business’s balance sheet, an important financial statement usually generated with accounting software. If a business entered unearned revenue as an asset instead of a liability, then its total profit would be overstated in this accounting period. The accounting period were the revenue is actually earned will then be understated in terms of profit.

It is a liability because even though a company has received payment from the customer, the money is potentially refundable and thus not yet recognized as revenue. https://www.bookstime.com/ is a liability account on a company’s books. The account balance represents the value of goods and services on which a company has received advance payments but has not yet performed the service or delivered the goods by the end of the period. As a liability account, it is used only when a company maintains its books using the accrual basis of accounting.

Accounting for https://www.bookstime.com/the-accounting-equationUnearned revenue is usually classified as a current liability for the business that receives it. When a business takes in unearned revenue, it must record the payment by debiting its cash account for the amount of money received in advance and crediting its unearned revenue account.

A company shows these on the balance sheet. A liability occurs when a company has undergone a transaction that has generated an expectation for a future outflow of cash or other economic resources. In financial accounting or accrual accounting, accruals refer to the recording of revenues that a company may earn, but has yet to receive, or the expenses that it may incur on credit, but has yet to pay. In simple terms, it is the adjustment of accumulated debts and credits. As an example, we note that Salesforce.com reports unearned revenue as a liability (current liabilities).

A final example of unearned income that is particular to hotels is an attrition or penalty charge to a group that does not meet its commitment of room nights. In many cases this charge includes an, “if you re-book” clause that states the customer can get a credit for some or all of the penalty charged if they bring the hotel an additional piece of business. Just like the rent example above, we cannot recognize this payment as income until it is earned.

Popular Industries where Deferred Revenue is common includes Airline Industry (tickets booked by the customer in advance), Insurance Industry (Insurance premium is always paid in advance), Legal Firms (Legal retainer paid in advance), and Publishing Firms (subscription paid in advances) such as Negative Retained Earnings Magazine etc. An airline Industry usually receives the advance payment of tickets booked by customers but the actual service (travel date) usually happen at a later date and such industries are required to report the same in the Financial Statements as per the methods discussed henceforth.

Unearned revenue is most common among companies selling subscription-based products or other services that require prepayments. 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.