Revenues refer to any income earned by a company or business. For most companies, revenues come as a result of selling products or services. However, sometimes companies may also transfer goods and not receive funds for it but still need to record the revenue related to it. On the other hand, companies may receive money even if they haven’t transferred goods yet.
What are unearned revenues?
Unearned revenues refer to any funds that companies receive for future sales. In other words, unearned revenues represent prepaid revenues. While referred to as unearned revenues, they do not represent revenues at all. It is because accounting standards don’t allow companies to record revenues unless they meet performance obligations.
Another name for unearned revenue is deferred revenues. The reason why companies can’t record unearned revenues as sales is because of the accruals concept of accounting. For example, unearned revenues may include rents received by a company or business for future periods, or advances paid by customers to book future sales.
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.
As mentioned, accounting standards do not allow companies to record unearned revenues as income. It is because, to recognize revenues, companies must meet two requirements. Firstly, they must transfer goods or services to the customer. Secondly, they must ensure, with reasonable certainty, that the customer can pay for those goods.
While unearned revenues meet the second requirement as the customers pay the company in advance, it does not satisfy the first requirement. Therefore, the company can only record income when it delivers the goods or services to the customer. In standard terms, the company must meet performance obligations associated with the contract to record revenues.
However, companies still need to record the cash received from its customers to reflect a true and fair position on its financial statements. Therefore, they classify the unearned revenues as liabilities. It is because until the company makes the sale, the amount paid by the customer is an obligation that will result in a future economic outflow.
Almost all the times, 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. However, these cases are rare.
The journal entry to record unrecorded revenues is straightforward. 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.
Therefore, the journal entry to record unearned revenues is as follows.
|Dr||Cash or bank||x|
|Cr||Unearned revenues (liability)||x|
Once 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.
|Dr||Unearned revenues (liability)||x|
If the customer does not end up buying products or services, they may want a refund for the amount. While these cases seldomly occur, the journal entry for it is as follows.
|Dr||Unearned revenues (liability)||x|
|Cr||Cash or bank||x|
A company, ABC Co., receives a $10,000 advance through its bank account from a customer, XYZ Co., for future sales. Since ABC Co. has not transferred any goods or services in exchange, it must use record the amount as a liability. Therefore, the accounting treatment for the transaction will be as follows.
|Cr||Unearned revenues (XYZ Co.)||$10,000|
After a month, ABC Co. sells $10,000 worth of goods to XYZ Co. against the amount received in advance. Therefore, the journal entry to record this transaction is as follows.
|Dr||Unearned revenues (XYZ Co.)||$10,000|
Unearned revenues represent cash received by a company or business against which it hasn’t made a sale. The accounting standards require companies to record unearned revenues as liabilities and not as actual revenues.
Subsequently, when a company makes a sale against the advance amount, it can remove the balance from liabilities and record the sale.