Table of Contents Hide
- What is Unearned Revenue?
- What Type of Account is Unearned Revenue?
- How do I account for Unearned Revenue?
- Examples of Unearned revenue
- How to Track Unearned Income
- What Is the Difference Between Deferred Revenue and Unearned Revenue?
- Where Are Records of Unearned Revenue Kept?
- When Is Unearned Income Acknowledged?
- Frequently Asked Questions
Are there times you get a payment for a job you’re yet to deliver and you wonder what that is? That is why we have written this article on unearned revenue to let you know the process involved.
What is Unearned Revenue?
Unearned revenue is money received by a person or business for a good or service that hasn’t yet been rendered or supplied. It can be viewed as a ‘prepayment’ for products or services that an individual or business expects to provide to the buyer at a later time.
This treatment entails a duty by the seller up to the good or service is delivered equal to the income earned. Other names for unearned revenue are advance payments and deferred revenue.
What Type of Account is Unearned Revenue?
As was already mentioned, unearned revenue is an obligation that the business has not yet paid. Therefore, the business handles the delivery of the prepaid good or service, thus it must reimburse the customer if it is not possible to supply it or if the customer cancels the order.
Since prepaid products and services are often provided or cancelled within one fiscal year, unearned revenue is reported as a current liability rather than a long-term one. Other examples of additional liabilities in accounting are accounts payable, bank overdrafts, accumulated expenses, income tax liabilities, capital leases, etc.
How do I account for Unearned Revenue?
According to accounting reporting rules, unearned revenue is a liability for a business that has been paid. Hence, the justification for this is that even after a consumer has paid the business, the creation still owes the delivery of a good or service.
The revenue that was previously recognized as a liability is recorded as revenue once the delivery of the products or services is complete.
Because the obligation is often satisfied in less than a year, unearned revenues are typically categorized as short-term obligations.
The associated unearned revenue, however, may be recognized as a long-term liability in some circumstances when the delivery of the products or services may take longer than a year.
See Also: Imprest: Definition And How It Works
Examples of Unearned revenue
The following are examples of unearned income:
- A down payment for a rental
- A services agreement with a down payment
- Advance-paid retainer for legal counsel
- Paid-up insurance
How to Track Unearned Income
To track unearned revenue, there are two journal entries you must make. One; is to acknowledge the treatment and the other, is to transform it into service revenue once it is earned.
Prepayments are recorded as a debit to the cash account and a credit to unearned revenue. Following that, an adjustment entry is reduced to credit service revenue and debit unearned revenue whenever the order or service is finished.
Below is an illustration to better understand what that means. If a business client says $200 annually for a membership, here’s how the journal entry should reflect the revenue recognition as a liability at the time.
After the membership period ends, unearned revenue is converted into service revenue with this adjusting entry:
Related article: Vouching: Difference Between Tracing and Vouching In Audit
What Is the Difference Between Deferred Revenue and Unearned Revenue?
Unearned revenue and deferred revenue refer to the same crucial accounting concept. Both terms refer to the compensation for goods or services that have not yet been delivered to a company.
Where Are Records of Unearned Revenue Kept?
Unless the goods and services will be delivered a year r more after the treatment date, unearned revenue is reported on a company’s balance sheet under short-term liabilities. If so, unearned income is recorded alongside long-term liabilities.
The service poses a risk to the organization because it is possible that it won’t be provided (either because a consumer cancels or a business is unable to do so).
Money will eventually be acknowledged but until the work is done, it can’t be assured. Hence, it will remain an obligation until the possibility of treatment has passed.
When Is Unearned Income Acknowledged?
Businesses are required to recognize revenue under ASC 606 when they have given goods or services equal to the sum received in exchange for the same goods or services.
The 5 steps in this method are:
- Locate and go over the contract with the client.
- Determine what the contract’s commercial responsibility is.
- Calculate the right sum for the transaction.
- Put that money towards the agreed-upon commitment.
- As soon as the company fulfils the obligation, recognize the revenue.
Frequently Asked Questions
Calculating unearned revenue is not too difficult. It is the total of all deposits made by customers and payments made in advance for goods and services. It rises with each subsequent payment made by a customer and falls as time goes on and the revenue is received.
Unearned revenue is reflected on the liabilities side of the balance sheet since the company took cash payments beforehand and consequently has unfulfilled obligations to its consumers.
Unearned revenue must be reported as a liability under the reporting standards of accounting.
Unearned revenue is a frequent sort of accounting problem particularly in service-based sectors. It’s also helpful for investing because unearned revenue frequently offers new perspectives on a company’s prospective future earnings.