Unearned Revenue Types & Examples What is Unearned Revenue? Video & Lesson Transcript

If the unearned revenues is what type of account was not to deal with unearned revenue in this manner, and instead recognize it all at once, there would initially be an understatement in revenues and profit. On the other hand, there will be an understatement for the additional periods during which the revenues and profits were supposed to have been recognized. This also violates the matching principle since the company recognizes the revenues at once while it does not recognize related expenses until later periods. Unearned Revenue is considered as a liability from the perspective of the company. This is primarily because of the fact that the company has received an advance, against which work or service has not yet been provided. Therefore, there is a need to categorize unearned revenue accordingly, since the company does not own this amount.

Taxes are only paid at certain times during the year, not necessarily every month. Taxes the company owes during a period that are unpaid require adjustment at the end of a period. Accounts Receivable increases for $1,500 because the customer has not yet paid for services completed.

How to adjust your chart of accounts

If the contract were cancelled and the good or service was not provided, then the company would need to refund the money the customer paid in advance. For this reason, unearned revenue is considered a liability until the good or service is provided, at which point it can be booked as earned revenue or sales revenue. Therefore, the journal entry to record unearned revenues is as follows.

For the income or revenue to become earned, the company must provide the good or service that the customer paid in advance for. In this article, we shall look at what unearned revenue implies, the account it falls under, its journal entries, and its importance to a business. Almost all the time, unearned revenues are short-term as customers don’t pay for goods or services beforehand in the long term. Therefore, companies must classify unearned revenues as current liabilities. However, in cases where a company receives money for sales that it expects to make after a year, it can also classify unearned revenues as non-current liabilities. In accounting, unearned revenue has its own account, which can be found on the business’s balance sheet.

Financial Accounting

Recall that unearned revenue represents a customer’s advanced payment for a product or service that has yet to be provided by the company. Since the company has not yet provided the product or service, it cannot recognize the customer’s payment as revenue. At the end of a period, the company will review the account to see if any of the unearned revenue has been earned. If so, this amount will be recorded as revenue in the current period. For example, XYZ Company sells insurance, and their customers routinely pre-pay for 12 months of insurance at a time.

As the prepaid service or the business gradually delivers the product over time, it is recorded as revenue on the income statement. As previously stated, unearned revenue is usually recorded as a current liability on a company’s balance sheet. If for example, a publishing company accepts $1,200 for a year subscription, the amount will be recorded as an increase in cash as well as an increase in unearned revenue. Both are balance sheet accounts, so the transaction will not have an immediate effect on the income statement. If it is a monthly publication, the liability or unearned revenue will be reduced by $100, that is, $1,200 divided by 12 months while revenue is increased by the same amount. The journal entry to record unrecorded revenues is straightforward.

Accrued Expenses

Unearned revenues are common in modern business, with almost all established companies taking advances for future sales. For example, below is a snapshot of Apple Inc.’s financial statements showing ‘deferred revenues,’ which represents money they have received for future sales. Creating and adjusting journal entries for unearned revenue will be easier if your business uses the accrual accounting method, of which the revenue recognition principle is a cornerstone. Hence, as per the accrual concept, revenue is going to be recorded as they are earned by the company. When the three-month period ends, there would be no unearned revenue pertaining to this transaction.

Unearned revenues are more common in insurance companies and subscription-based service providers. Deferred revenue and prepaid expenses are important concepts in accrual accounting. Entities can record advance payments received and made when dealing with long-term contracts. Unearned revenue is important to the accrual method of accounting. On the first of August, the company sells a machine for a total of four thousand dollars.

Since the company receives money through either cash or bank, it must increase the related account with a debit entry. On the other hand, it must also increase its liabilities through a credit entry. The name for the account it uses may be unearned revenues, deferred revenues, advances from customers, or prepaid revenues. Deferrals are prepaid expense and revenue accounts that have delayed recognition until they have been used or earned.

It is because, to recognize revenues, companies must meet two requirements. Secondly, they must ensure, with reasonable certainty, that the customer can pay for those goods. At this point, you may be wondering how to calculate unearned revenue correctly. When a customer prepays for a service, your business will need to adjust its unearned revenue balance sheet and journal entries. Your business will need to credit one account and debit another account with the correct amounts using the double-entry accounting method.

Under accrual accounting, the four thousand dollar purchase is recorded as revenue the instant the sale is made, even if the customer does not send payment until the twentieth of August. Unearned revenue is recognized in accrual accounting, but not in cash accounting. DrCash or bankxCrUnearned revenues xOnce 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. Therefore, the journal entry for recording an eventual sale against unearned revenues is as follows.

Let’s say a company pays $8,000 in advance for four months of rent. After the first month, the company records an adjusting entry for the rent used. The following entries show initial payment for four months of rent and the adjusting entry for one month’s usage. In cases like ABC Company, you would record the revenue once the pallets are transferred to the customer.

• So, using our XYZ Company insurance example, let’s say you sell a 12-month policy for $1,200 and receive the money January 1st; the policy takes effect on January 1st.
• Therefore, companies must classify unearned revenues as current liabilities.
• Some sources of unearned income are taxed as ordinary income, whereas others enjoy more generous tax rates.
• For example, if a customer purchases a policy from an insurance company at the beginning of the year and pays for twelve month of coverage, the payment made is considered unearned revenue.

It’s extremely important that at the end of each month, you run a close check on all your company’s financial statement – balance sheet, P/L statement, and cash flow statement. This is crucial to ensure that all closing entries are recorded and that statements are a true reflection of your company’s financial health. Similar to the immediate recording of revenue earned, any expense incurred should also be immediately become a part of your company’s accounts book.

The company does not use all six months of insurance immediately but over the course of the six months. At the end of each month, the company needs to record the amount of insurance expired during that month. For example, let’s say a company pays $2,000 for equipment that is supposed to last four years. The company wants to depreciate the asset over those four years equally. This means the asset will lose $500 in value each year ($2,000/four years). In the first year, the company would record the following adjusting entry to show depreciation of the equipment.

Unearned revenue or deferred revenue is considered a liability in a business, as it is a debt owed to customers. It is classified as a current liability until the goods or services have been delivered to the customer, after which it must be converted into revenue. From a cash flow perspective for the seller, this possesses an advantage who has the cash to perform the required services or to provide the required goods. It can also be beneficial as it allows the seller to perform other activities such as making an interest payment on debt and making purchases of more inventory. Once the seller delivers the product or service, unearned revenue becomes revenue on the income statement. Unearned revenue refers to the money that a business receives from a customer for work that is yet to be performed.

There will be changes in this if advance payments are made for goods or services due to be provided 12 months or more after the payment date. If such cases occur, then unearned revenue will appear as a long-term liability on the balance sheet. In essence, unearned revenues are generally classified as short-term liabilities because the obligation is usually fulfilled within a period of less than a year. In some cases, the delivery of goods and services may take more than a year, in this case, the unearned revenue will be recognized as a long-term liability. In accordance with the accrual principle of accounting, companies are required to record revenues that have been earned, and expenses that have been incurred. In other words, only revenues and expenses relevant to the current year are supposed to be included in the financial statements for the given year.

Some examples include interest, and services completed but a bill has yet to be sent to the customer. Similar to prepaid insurance, rent also requires advanced payment. Usually to rent a space, a company will need to pay rent at the beginning of the month. The company may also enter into a lease agreement that requires several months, or years, of rent in advance. Each month that passes, the company needs to record rent used for the month.

Since ABC Co. has not transferred any goods or services in exchange, it must record the amount as a liability. Therefore, the accounting treatment for the transaction will be as follows. Here is an example of Beeker’s Mystery Box and what their balance sheet might look like. As you can see, the unearned revenue will appear on the right-hand side of the balance sheet in the current liabilities column.

It’s also possible with some types of unearned income to defer tax liabilities to a later date. Let us understand how unearned revenue balance sheet documentation is carried out with the help of a few examples. These examples will give us more relevance as they have been curated keeping daily situations in mind. Let us understand the steps involved in the unearned revenue balance sheet entry through the detailed step-by-step process below. Similarly, the generally accepted accounting principles have introduced to us the matching principle.

Once it’s been provided to the customer, unearned revenue is recorded and then changed to normal revenue within a business’s accounting books. The unearned revenue concept is common in industries where payments are received in advance. The accrual method of accounting requires revenues and expenses to be recorded in the period that they are incurred, regardless of the time of payment or receiving cash. Since the accrued expenses or revenues recorded in that period may differ from the actual cash amount paid or received in the later period, the records are merely an estimate. The accrual method requires appropriate anticipation of revenues and expenses. The journal entry for unearned revenue shows a debit to the unearned revenue account and a credit to the cash account.

There are many types of unearned or passive income, including interest from savings accounts, bond interest, alimony, and dividends from stocks. Unearned revenue refers to the compensation or payment received by an individual or an organization for products or services that are yet to be delivered or produced. These prepayments help companies to better their cash flows and produce the product or service with lesser hassle. By the end of the fiscal year, you will have delivered all 12 magazines for the year, and the balance on your deferred revenue account will amount to zero.