Unearned revenue represents income received by the organization in the reporting period but related to future reporting periods. In the composition of unearned revenue is a receipt for goods or services, the delivery of which will last a long time or will be done sometime in the future, but payment has already been received. Such income may include the following:
- Rent. The rent/lease may provide for payment in advance for a certain time. Unearned revenue may be recognized as security, which is paid at the beginning of the lease, but is offset against it last month.
- Advance payments are funds transferred by the agreement for goods or services that have not yet been provided to the buyer but will be delivered later following the agreement. Unearned revenue will be recognized if the advance payment is made more than one accounting period in advance.
- Subscription (prepayment) for periodicals or other services.
- Sale of tickets to various events, shows, flights, etc. Revenue from subscription and long-term obligations, for example, income from the transportation of passengers who bought a “travel card” for a quarter or a year at once, a subscription fee for communication services, etc.
However, an expected revenue cannot be considered unearned revenue. For example, if the company signed a contract for a large batch of products but has not received the payment for the goods yet, nothing will be recorded in the accounting records. Note that the increase in unearned revenue account indicates the growth of the company’s work aimed at attracting contractors, the intensity of the provision of services or goods.
Unearned revenue is also often referred to as deferred revenue. Deferred revenue, however, usually refers to advance payments that will be fully earned in the long term (over one year). Unearned revenue, on the other hand, is payments for products or services that will be received within a year.
Is Unearned Revenue a Liability?
Counting income is always psychologically more pleasant than an expense. Income is funds that an individual or organization receives or intends to acquire, thereby increasing their assets. Seeing the words unearned and revenue, many are in doubt: is unearned revenue a liability or an asset? Despite being a revenue that a company received, unearned revenue is considered a commitment on the balance sheet if the company uses accrual accounting method, which recognizes revenue only when it is earned.
“Why is unearned revenue a liability? Since unearned or deferred revenue has not been earned yet, it is regarded as an obligation or, in other words, liability. The company still owes goods or services to its customers and is likely to even inquire about expenses associated with the production or delivery of these products or services. Unearned revenue will turn into an asset and be considered a profit only when the company fulfills its obligation before the customers.
Accounting for Unearned Revenue
It often happens that an enterprise simultaneously receives income for several reporting periods at once, for example, annual (quarterly) payment for leased property, payments for subscriptions or tickets, etc. That is, the company accepts prepayments for goods or services, the profits from the provision of which should be taken into account in the future.
How does one account for deferred income and correctly distribute revenue corresponding to each reporting period? Income received during the current period but relating to future reporting periods is taken into account separately from the income received for the current period. Individually, unearned revenue, as mentioned above, is considered a liability and recorded as one under an account named Unearned Revenue.
A credit balance in the unearned revenue account indicates that the company has a balance of revenues that will be recognized as revenue in the period that is directly related to the payment. In other words, this account will decrease as the goods or services are provided, and the company earns the income it received in advance.
One of the main objective of the checking the unearned revenue account at the end of the reporting period is to verify the accuracy of the information on the account and the corresponding delivery of services or products, as well as the compliance of the reflection of these operations with the accounting policies adopted by the company.
Unearned Revenue Entries
The payment for goods or services not yet rendered would be initially recorded as a debit to Cash account and credit to Unearned Revenue. For example, a leasing company received payment for three months of a lease of $9,000. Once the payment is received, the following entry will be made:
|Unearned revenue (liability)||9,000|
Next month, when one month of lease period has passed, an adjustment entry will be made:
Two more adjusting entries will be made at the end of the next two months until the prepaid lease will be used, and the company earns the money it received in advance.