What Is Unearned Revenue? A Definition and Examples for Small Businesses

Unearned revenue refers to the sales or service revenue that a company gets paid in advance by a customer before the customer receives the good or service. As a result of this prepayment, the company has a liability that is equal to the unearned revenue amount until they deliver the good or service. This is normally a current liability as the obligation is usually completed within a fiscal year. The customer on the other hand records the prepayment as an asset known as prepaid expenses.

The adjusting entry ensures that the correct amount of revenue earned appears on the income statement, not as a liability on the balance sheet. For help creating balance sheets that can track unearned revenue, consider using QuickBooks Online. This accounting software offers a wide range of financial reporting capabilities, along with expense tracking and invoice features. There are two alternative approaches to record the journal entry of this type of transaction and the subsequent adjustment entries to recognize the revenue when becomes earn. These two main distinctions come from different journal entries both on the receipt date and at the revenue recognition date. Accounting records that do not include adjusting entries to show the earning of previously unearned revenues overstate total liabilities and understate total revenues and net income.

Liability Method

This adjusting journal entry for unearned revenue is made in compliance with Generally Accepted Accounting Principles (GAAP) and is used to track payments made in advance for goods or services. Before we discuss this adjusting entry, let us have a clearer understanding of unearned revenue. Under the income method, the first journal entry to record the advance receipt is directly recorded to the revenue account. As mentioned above, because the goods or services have not been delivered or rendered, such receipt shall not be recorded as revenue. Therefore, there is another adjusting entry to transfer some unearned portion to the unearned revenue account. This ensures that the company does not provide misleading information to its shareholders and creditors by presenting unsubstantiated balance sheets or income statements.

When expenses are subtracted, interest must be paid on the remaining value. Before we understand what unearned revenue is, we must fully understand what revenue is. Then we can look at the difference, how it is treated in financial reports, and what it means for an organization’s ability to increase its competitive advantage. The unearned amount and the organization’s revenue are both credited when they are written as journal entries. However, the unearned value must be adjusted when the organization finishes the transaction and earns the revenue.

Benefits Of Unearned Revenue

Let’s work through another example of how to record unearned revenue. Accounts receivable are those receiving the goods or services unearned revenue before paying for them. Unearned amounts are when the customer pays before they receive the service or goods from the organization.

The revenue that an organization earns is essential to the ongoing survival of the company and determines its ability to become profitable. It is an indicator of the organization’s ability to sell goods and services to customers. Below you’ll find everything you need to know about unearned revenue and how it affects your small business.

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The company will then repeat the same process each time a lawn service is performed until its liability is reduced to zero. Accounting for unearned revenueUnearned 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. As the company earns that revenue, https://www.bookstime.com/ it reduces the balance in the unearned revenue account (with debit entries) and increases the balance in the revenue account (with credit entries). Once goods or services have been rendered and a customer has received what they paid for, the business will need to revise the previous journal entry with another double-entry. This time, the company will debit its unearned revenue account while crediting its service revenues account for the appropriate amount.

• If they find themselves in a situation where they have used the money, and the customer wants a refund, they have to raise more.
• Let’s start by noting that under the accrual concept, income is recognized when earned regardless of when it is collected.
• Unearned revenues are payments for future services to be performed or goods to be delivered.
• Unearned revenue is a key element of a company’s financial position and must be tracked accurately.
• Generally, unearned revenues are classified as short-term liabilities because the obligation is typically fulfilled within a period of less than a year.

The company can make the unearned revenue journal entry by debiting the cash account and crediting the unearned revenue account. When a company receives cash in advance, it creates an obligation to provide goods or services. The advance receipt shall be treated as deferred revenue and only recognize as the real revenue when the goods are delivered or services are rendered. 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. At the end of the six months, all unearned revenue has converted into revenue, since all money received accounts for the six mystery boxes that have been paid for.

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The adjusting entry for deferred revenue updates the Unearned Fees and Fees Earned balances so they are accurate at the end of the month. The adjusting entry is journalized and posted BEFORE financial statements are prepared so that the company’s income statement and balance sheet show the correct, up-to- date amounts. At the end of the month, you make an adjusting entry for the part of that pre- payment that you did earn because you did do some of the work for the customer during the month. At this time you debit Unearned Fees for the amount of service provided, which reduces what you owe the customer. The credit part of the adjusting entry is the revenue account, whose value is increased by the amount earned. Any remaining balance in the liability account is what you still owe and have left to earn in the future.

Unearned revenue is a key element of a company’s financial position and must be tracked accurately. Income or revenue is earned when the process of providing goods or services has been completed. Any income or revenue that is received before being earned is known as unearned income or income received in advance. Perhaps the biggest impact would be inaccurate financial statements, with revenue totals overstated in the month when the prepayment is received, and understated in all subsequent months.

The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. The more cash on hand, the better for the organization, as it will increase its quick ratio.

• At the end of the six months, all unearned revenue has converted into revenue, since all money received accounts for the six mystery boxes that have been paid for.
• Accounting records that do not include adjusting entries to show the earning of previously unearned revenues overstate total liabilities and understate total revenues and net income.
• At the end of the month, you make an adjusting entry for the part of that pre- payment that you did earn because you did do some of the work for the customer during the month.
• In accounting, unearned revenue has its own account, which can be found on the business’s balance sheet.
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