What is Unearned Revenue? Is It an Asset or Liability?

Under the percentage-of-completion method, the company would recognize revenue as certain milestones are met. Under the completed-contract method, the company would not recognize any profit until the entire contract, and its terms were fulfilled. As a result, the completed-contract method results in lower revenues and higher deferred revenue than the percentage-of-completion method. Since customers deem this prepayment for their goods and services as their assets, it adds to their sense of security that the deliverables will be delivered as promised. Though investors should be aware that the shift in the balance may be the result of a change in the business, unearned revenue can provide hints about future revenue. When they pay the rest and complete the transaction, they need to adjust the accounts.

• This introduces the complexity of financial reporting, especially with businesses that have different revenue streams.
• You record prepaid revenue as soon as you receive it in your company’s balance sheet but as a liability.
• You record it under short-term liabilities (or long-term liabilities where applicable).
• In some cases, the business needs to reflect this in their accounting.
• The balance of the $12,000 payment remains in unearned revenue until goods and/or services have been delivered for February.
• This will help promote consistency and accuracy in managing unearned revenue.

Example of Deferred Revenue Accounting

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. Look below to see an example of the two journal entries your business will need to create when recording unearned revenue.

• The liability is reduced as the company fulfills its obligations, and the revenue is recognized in the income statement.
• The adjusting entry for unearned revenue will depend upon the original journal entry, whether it was recorded using the liability method or income method.
• Since you haven’t delivered on all the website support throughout the year yet, you should classify the support fee separately in your contract, and only recognize that revenue as you earn it.
• By properly managing unearned revenue and fulfilling their obligations, companies can maintain customer satisfaction, improve cash flow, and enhance their overall financial performance.
• Correcting these discrepancies is essential for presenting accurate financial statements.

Adjusting entry for unearned revenue

You record prepaid revenue as soon as you receive it in your company’s balance sheet but as a liability. Therefore, you will debit the cash entry and credit unearned revenue under current liabilities. After you provide the products or services, you will adjust the journal entry once you recognize the money. At this point, you will debit unearned revenue and credit revenue. Unearned revenue is a financial term that represents payments received by a company for goods or services that have not yet been provided or delivered. This occurs when customers prepay for a product or service, resulting in the company holding the funds as a liability on their balance sheet until the goods or services are delivered or rendered.

• Most businesses provide upfront work or goods before invoicing their clients.
• There is always an element of uncertainty with advance payments received from buyers.
• In cash accounting, the seller will only record an advance payment for an order rather than recording two entries in the journal.
• Some of the limitations of unearned revenues are discussed below.

You shouldn’t spend it the same way you spend regular cash

Until the service is performed or the good is delivered, the company is indebted to the customer, making the revenue temporarily a liability. Once earned, the revenue is no longer deferred; it is realized and counted as revenue. The owner then decides to record the accrued revenue earned on a monthly basis. The earned revenue is recognized with unearned revenue a liability an adjusting journal entry called an accrual. Unearned revenue refers to income received from a customer for products or services that are yet to be delivered. Say a company has a balance of unearned revenue for services it intends to provide within a year, this balance is considered a current liability and would decrease the working capital.

By not doing so, a company overestimates its working capital, which could later cause issues by creating cash flow problems. Perform a monthly check of your balance sheet and the income statement. If you have booked revenue too early you will need to start from scratch and recalculate your earnings for all accounts. Improper revenue recognition will result in an overstated revenue account balance, and understated deferred income account balance. Since service is owed, it is considered a short-term or long-term liability. Once revenue recognition occurs, it is earned revenue and becomes income.

How Unearned Revenue is Recorded

If you have earned revenue but a client has not yet paid their bill, then you report your earned revenue in the accounts receivable journal, which is an asset. Unearned revenue, sometimes called deferred revenue, is when you receive payment now for services that you will provide at some point in the future. In the world of accounting, unearned revenue requires adjustments and corrections to ensure accurate representation of a company’s financial statements.

Recording Unearned Revenue

Effectively managing unearned revenue is essential for businesses to maintain customer satisfaction, ensure accurate financial reporting, and optimize cash flow. On a balance sheet, the “assets” side must always equal the “equity plus liabilities” side. Hence, you record prepaid revenue as an equal decrease in unearned revenue (liability account) and increase in revenue (asset account).

We are simply separating the earned part from the unearned portion. In the entry above, we removed $6,000 from the $30,000 liability. According to the accounting reporting https://www.bookstime.com/ principles, unearned revenue must be recorded as a liability. Sometimes you are paid for goods or services before you provide those services to your customer.

Recognize and record your revenue properly

If the company fails to deliver the promised product or service or a customer cancels the order, the company will owe the money paid by the customer. Some examples of unearned revenue include advance rent payments, annual subscriptions for a software license, and prepaid insurance. The recognition of deferred revenue is quite common for insurance companies and software as a service (SaaS) companies. Unearned revenue refers to the money small businesses collect from customers for their products or services that have not yet been provided. In simple terms, it is the prepaid revenue from the customer to the business for goods or services that will be supplied in the future. Businesses, large and small alike, must ensure their bookkeeping practices comply with accounting standards like GAAP.

It’s crucial to understanding your company’s cash flows

Also referred to as deferred revenue, unearned revenue is considered as a form of prepayment, where the purchaser pays for a product or service before actually receiving it. Since payment is already made by the consumer, the supplier has a responsibility to follow through with the delivery when it’s ready to do so. Unearned revenue and deferred revenue are similar, referring to revenue that a business receives but has not yet earned.