Why is unearned revenue a liability?

There are several industries where prepaid revenue usually occurs, such as subscription-based software, retainer agreements, airline tickets, and prepaid insurance. Unearned revenue is recorded on a company’s balance sheet as a liability. It is treated as a liability because the revenue has still not been earned and represents products or services owed to a customer. As the prepaid service or product is gradually delivered over time, it is recognized as revenue on theincome statement. Unearned revenue is also known as deferred revenue or deferred income.

The unearned revenue account is usually classified as a current liability on the balance sheet. Unearned revenue is a type of liability that is recorded on the balance sheet of a business. It represents an obligation to deliver goods or services in the future, for which payment has already been collected. Unearned revenue is also referred to as a prepayment, deferred revenue, or advanced payments.

Is deferred revenue a debit or credit in accounting?

Since the deliverable has not been met, there is potential for a customer to request a refund. If you don’t enter revenue received in the same accounting period that expenses were paid, this also violates the standard accounting principles. As a result, unearned revenue is a liability for any company that has already received payment without delivering the product. If the company failed to deliver, it would still owe that money to the customer so it cannot be recorded as revenue just yet. After delivery, the payment switches from liability to revenue. Unearned revenue is a liability for the recipient of the payment, so the initial entry is a debit to the cash account and a credit to the unearned revenue account. As a company earns the revenue, it reduces the balance in the unearned revenue account and increases the balance in the revenue account .

That way the entries to Refund Clearing, the one generated by iMIS and the one used to record the payable or payment issued, will offset and net to zero. Just because you have received deferred revenue in your bank account does not mean your clients will not ask for a refund in the future. Additionally, some industries have strict rules governing how to treat deferred revenue. For example, the legal profession requires lawyers to deposit unearned fees into anIOLTA trust accountto satisfy their fiduciary and ethical duty. The penalties for non-compliance can be harsh—sometimes leading to disbarment. Unearned revenue represents a business liability that goes into the current liability section of the business’ balance sheet.

Understanding Unearned Revenue

Read on to understand more real-world examples of unearned revenue as well as its benefits and how it should be recorded. As the company is delivering the services or the product over time gradually, then the prepaid amount is being earned by the company, and it is recognized as revenue on the company’s income statement. Assuming that XYZ Limited, a publishing company, accepts $24,000 for a six-month subscription, an accountant records the amount as an increase in cash and an increase in unearned revenue. In each case, the figure appears in the balance sheet accounts meaning income statements are not affected immediately. So if the publications are to be delivered monthly, every time each monthly portion is delivered, the current liability is reduced by $4,000 ($24,000 divided by six months).

• Earned revenue means you have provided the goods or services and therefore have met your obligations in the purchase contract.
• An example of unearned revenue might be a publishing company that sells a two-year subscription to a magazine.
• If all of the money is not earned, such as a cancelled contract, the transaction must be handled differently.
• The unearned revenue account will be debited and the service revenues account will be credited the same amount, according to Accounting Coach.

A wide range of different industries make use of deferred or unearned revenue. You won’t see accrued revenue on the books for very long in most businesses. That’s because accrued revenue only exists when money has been earned, but not yet invoiced. They’re referring to the same thing, so you can use these two terms interchangeably.

Example 2: Cash Flow and Production Burden

Classic examples of unearned revenue include rent payments made in advance, prepayments for newspaper subscriptions, annual licenses for the use of software, and much more. A prepayment adjusting entry would be noted on the books for January. You also need to enter a credit of $4800 to the deferred revenue account. The subscription for monthly accounting service is considered a short-term liability on the balance sheet. Unearned revenue is recognized as a current liability on the balance sheet. As the obligation related to the unearned revenue is delivered over time, the liability decreases as the amount is transferred to revenue on the income statement.

This liability is noted under current liabilities, as it is expected to be settled within a year. As the unearned revenue account is debited and the cash account is credited, the amounts change classification on the balance sheet. Where once the $5,000 was a liability, it is now a cash asset on the income statement. The $5,000 payment you’ve received from your clients for the premium experience is considered unearned revenue. While you have been able to bring your clients in on a new premium experience, your business has yet to provide the services or products that have been promised in return for the opt-in. For this reason, the revenue is considered “unearned” and is recorded as a liability in the books.

INVESTMENT BANKING RESOURCESLearn the foundation of Investment banking, financial modeling, valuations and more. This marks the amount you earn each month, and keeps you compliant. If you are questioning is unearned revenue a liability your reporting, an accountant can help you work out the kinks. It is the seller’s choice to prorate the refund or to charge additional fees. Recognize revenue when services or goods have been performed.

Unearned revenue, sometimes called deferred revenue, is when you receive payment now for services that you will provide at some point in the future. Unearned revenue is a common type of accounting issue, particularly in service-based industries.

What is the accounting entry for unearned revenue?

Unearned revenue represents money received by the company for services that have yet to be performed. As each of the premium service elements are implemented, additional entries are made by the bookkeeper to indicate that services have been provided to the client. For example, once the new staff is hired and trained, a $2,000 debit entry to unearned revenue is entered and a $2,000 credit entry to cash is entered. The journal entry that recorded the payment debits Cash for the full amount and with a full offset credit to Unearned Income. To see the related sales journal entry, select the date link under Related sales journal entries.

After the amount has been earned, the Unearned Income account is reduced, and a revenue account is increased. While unearned revenue refers to the early collection of customer payments, accounts receivable is recorded when the company has already delivered products/services to a customer that paid on credit.