Definition and meaning:
Unearned revenue is the cash obtained from a customer in advance of providing the goods or services they are purchasing.
It is considered a short-term liability instead of revenue because as per the revenue recognition principle of accounting, revenue is reported only when it is earned.
Since the company owes money to its clients as the obligations have not been performed yet, unearned revenue is reported as current liability on the balance sheet of a company.
Unearned revenue improves the liquidity and cash flow as the company now has enough cash to carry out its obligations easily. However, it may result in significant liabilities, which is rarely considered a good thing on your financial statements.
Unearned revenue is revenue or income that has been earned by a company but not yet recorded in its financial statements. This usually happens when the company has already provided the goods and services to its client but has not invoiced the customer yet.
As per the matching principle of accounting, all revenues and matching expenses should be reported in the same period they have been earned and incurred, respectively.
Unrecorded revenue goes against the matching principle of accounting as it results in revenue being recorded in a later period than it was actually earned in.
Financial Accounting and Reporting:
Unearned revenue is credit in nature and is reported as a real account in the books of the company. The journal entry to record unearned revenue is as follows:
Cash DR xx
Unearned Revenue CR xx
As the company supplies the goods or services owed and starts performing its obligations, the revenue is gradually earned. To finally recognize the revenue, the unearned revenue account is lessened, and the revenue account is increased as follows:
Unearned Revenue DR xx
Revenue CR xx
Unrecorded revenue on the other hand, as the name suggests, is not reported during the year.
However, if the company applies the matching principle thoroughly, what it could do is record adjusting entries at the end of the year to accrue the revenue that has been earned but not yet billed. The adjusting entry to record unrecorded revenue would be as follows:
Accounts Receivable DR xx
Accrued Revenue CR xx
Once the invoice is issued in a later accounting period, the entry could be reversed by crediting the accounts receivable and debiting the accrued revenue account.
A client purchases a fitness training package of $1,000 in advance where each session costs $50. The fitness trainer will record entry as follows:
Cash DR $1,000
Unearned Revenue CR $1,000
For instance, the client takes 5 sessions in the first month. The fitness trainer will have earned the revenue of 5 sessions i.e. $250, and by the end of the month, will record it as follows:
Unearned Revenue DR $250
Revenue CR $250
Similarly, for example, a company signs a multi-period contract. One of its terms is to record revenue only when the contract period ends.
Even if the company performs all its obligations and has earned the revenue as per the accounting principle, it can’t record the income in the current period, resulting in unrecorded revenue.
On the contrary to what the names suggest, unearned revenue and deferred revenue are both the same thing. They are both incomes for which the cash has been collected but the obligations of delivering goods as well as services are yet to be performed.
This concept arises from the accrual basis of accounting, which requires companies to report revenue immediately when it’s earned, and records expense immediately when it’s incurred, regardless of the cash coming in or going out.
Similarly, the generally accepted accounting principles (GAAP) have introduced to us the matching principle. It requires a business to report revenue in the same period the expenses to generate such income are incurred.
It means that if a customer purchases a book from you on 27th December 2018, but pays for it on 2nd January 2019, the sale will be considered done on 27th December, regardless of the payment coming in January of the next accounting period.
This is because, the materials used to produce the book were purchased in 2018 and not 2019 (matching principle), and the rights of the books were transferred to the customer in 2018 too, considering the sale to be made on credit.
Financial Accounting and Reporting for Deferred Revenue:
Unearned revenue or deferred revenue is considered a liability account for a company. Because the money is received even before the services or goods are performed or delivered, the amount is classified as a liability. The journal entry to report unearned or deferred revenue in the books of a company is as follows:
Cash DR xx
Unearned Revenue CR xx
Unearned revenue usually occurs in subscription-based trading or service industries where payments are taken in advance and services are performed later.
Since the GAAP requires us to book revenue as soon as it is earned, the revenue is proportionately recorded according to the work done throughout the contract period until the final good or service is delivered.
When a portion of the deferred revenue is earned, the deferred revenue account is lessened by a debit of the same amount whereas the revenue account is credited.
Unearned Revenue DR xx
Revenue CR xx
There are several examples of unearned revenue such as, payments received for annual subscriptions, prepaid rental income, annual payments for software, and prepaid insurance.
For example, you receive $600 for an annual subscription of magazines at the beginning of your accounting period. You have received, in cash, the entire $600 but have not yet delivered a single magazine to the customer. Your accountant will book the following entry at the beginning of the year:
Cash DR $600
Unearned Revenue CR $600
As the year progresses, you deliver the magazine every month throughout the year. Every month, for every magazine you deliver, you will record an entry recognizing the revenue and lessening the unearned revenue account as follows:
Unearned Revenue DR $50
Revenue CR $50
By the end of the fiscal year, you will have delivered all 12 magazines for the year, and the balance on your deferred revenue account will amount to zero. Simultaneously, each month $50 will be recognized and reported on your income statement.
Unearned Revenue can be defined as the money that is received by an individual or a company, in exchange for a service or a product that is yet to be provided or delivered.
Unearned Revenue can be defined as a prepayment for goods and services, that a company is expected to supply to the purchaser at a given later date.
As a result of this revenue that has been received in advance, it can be seen that there is an inherent liability in the form of unearned revenue unless the respective good or service has been delivered to the customer.
Unearned revenue can also be referred to as deferred revenue and advance payments.
As far as unearned revenue is concerned, it can be seen that it is recorded as a liability on the Balance Sheet, because it is the amount that the company has received, against which goods and services have not been delivered to the customer.
However, once these goods and services have been delivered to the customer, then the amount is shown as revenue on the Income Statement.
Examples of industries where this type of revenue is most common in the construction industry or the service industry where revenues are collected in advance, but service is rendered after regular time intervals across the year.
Therefore, with subsequent months of service delivery, the amount reduces from the Current Liabilities, and is then represented in the Income Statement.
On the other hand, as far as Accrued Revenue is concerned, it can be defined as revenue that has been earned by providing a good or a service, but no cash has been received against that.
In other words, it is the amount that is receivable from the customers, despite the fact that goods and services have been provided against the particular sale.
Accrued Revenue is mainly recorded as a receivable on the balance sheet, in order to reflect the amount of money that customers owe to the business, for the goods and services they have purchased.
The recording of accrued revenue is seen as part of the revenue recognition principle, which requires revenue to be recorded in the period when it is earned.
Regardless of the fact that the amount has not been received in cash for this particular sale transaction, yet it can be seen that this can be regarded as a current asset, primarily because of the fact that the company is likely to receive the amount for the sale that has been conducted.
Therefore, it can be seen that the main underlying difference between Unearned Revenue and Accrued Revenue is the fact that one of them is recorded as a Current Liability, whereas Accrued Revenue is recorded as a Current Asset.
Unearned Revenue is not shown in the Income Statement until the goods or services have been delivered against that sale, whereas Accrued Revenue is shown as an Income, regardless of the cash collection process.
Both of these revenue types are shown in the Financial Statements, regardless of the fact that they have been paid for, or not.
As far as unearned revenue is concerned, it can be seen that it is mainly defined as the amount that has been collected from the customer, but in return for the amount that has been collected, subsequent payment has not been collected.
Therefore, as a result of these non-collections, it can be considered as a Current Liability, because of the reason that goods and services are yet to be provided for against the amount that has been collected against these collections.
Hence in this regard, the revenue has been collected but has not been ‘earned’, in the sense that the company is yet to provide goods and services against this particular amount.
Therefore, the accounting treatment for Unearned Revenue is such that in the case when the amount is collected from the customers, it is treated so through the following journal entry.
Debit – Cash/Bank (To record collection of cash)
Credit – Unearned Revenue / (Current Liability) (To reflect that goods still have to be provided for against the cash received)
Subsequently, when the company completes the transaction, it can be seen that they reflect this amount in the Income Statement, which can be reflected in the following journal entry:
Debit – Unearned Revenue
Credit – Income Statement (Now that goods and services have been provided against the amount that has been generated, it can now be considered as Revenue generated from Sales)
Therefore, it can be seen that Unearned Revenue is a temporary account, which reflects the amount that is generated from customer payments that are yet to be serviced.
On the other hand, Accounts Payables can be referred to as the amount that is mainly payable to the creditors in exchange for goods and services that have been utilized or consumed by the company.
As a matter of fact, this particular amount includes figures for the probable payables to the creditors, in exchange for goods and services that they have provided.
This mainly occurs in the case where the company procures goods and services and then chooses to pay for them at a later time period. In this case, they then record the amount as a Current Liability, unless it has been paid for.
The relevant journal entry that is used to record the purchase of goods and services is given below:
Debit – Purchases
Credit – Accounts Payable (Current Liability)
After this amount has been paid for, the journal entry to record the transaction is as follows:
Debit – Accounts Payable
Credit – Cash/Bank
Therefore, it can be seen that the existing similarity between Accounts Payable and Unearned Revenue is the fact that both of them are treated as Current Liabilities.
However, one of them occurs as a result of payment that is received by the company (Unearned Revenue), whilst one of them occurs when the company is liable to pay their suppliers for the goods and services that they have procured over the course of time.
In the case of the Unearned Revenue, the account is supposed to be settled in exchange for goods and services, whereas in the case of Accounts Payable, the liability is settled with Cash.
Revenue recognition principle can be seen as a justification of accrual-based accounting, in line with matching principle to show that companies are able to record revenues and expenses in the respective financial year when they are actually incurred.
This has an accounting implication in the sense that it requires companies to record their revenues when they have actually earned it, as opposed to when they receive the payment or the compensation for it.
Subsequently, it requires companies to be able to record their revenue, and their expenses when they have actually incurred it.
As a result of this, recording revenue has to be considered in that aspect, so that revenues and expenses can be matched across a given time period only.
Revenue can simply be defined as the amount that is obtained by the companies in exchange for the goods and services that they provide.
Depending on the main operations of the company, this amount can vary from situation to situation, and hence, companies are likely to choose their approach towards recording revenue in accordance with how they collect this particular amount. Revenue can broadly be categorized into two types, earned revenue and unearned revenue.
As far as earned revenue is concerned, this is the amount that is generated against the sale of goods and services, which have already been provided to the buyer.
Therefore, it is a straightforward process, which requires recording these transactions in exchange for the goods and services that have already been provided for. The journal entry that is used to record revenue (earned) is as follows:
Debit – Cash / Accounts Receivable
Credit – Revenue (Income Statement)
On the other hand, unearned revenue is mainly generated when the company receives compensation for the goods and services in advance.
This amount is, therefore, treated as a current liability because of the fact that goods and services against this particular amount are yet to be paid for.
Unearned revenue is also referred to as deferred revenue. The journal entry that is required to record unearned revenue is as follows:
Debit – Cash / Bank
Credit – Unearned Revenue (Current Liability)
However, once the amount for Unearned Revenue has been settled, it can be seen that it is treated as Income, and recorded as earned revenue for the period. The relevant journal entry required to record this is as follows:
Debit – Unearned Revenue (Current Liability)
Credit – Earned Revenue / Income (Sales)
Therefore, it can be seen that Unearned Revenue is a type of revenue, which is not yet earned because the company has not provided goods and services against the payment that has been received for these goods and services.
However, once the company has provided the goods and services, the amount is then treated as revenue in the Financial Statements.
Therefore, it is of primitive importance to ensure that the company is able to set a clear distinction between revenue and unearned revenue, so that the stakeholders of the company are able to identify the amount that has been generated as advances for the company, in addition to the actual amount that has been earned over the period of time.
Revenue can be defined as the compensation that the company receives in exchange for goods and services that the company has provided over the course of time.
Revenue can be defined as either earned or unearned. As far as earned revenue is concerned, it can be seen that this is the amount equivalent to the worth of goods and services that the company has provided to their clientele.
On the other hand, as far as unearned revenue is concerned, it is the amount equivalent to the goods and services that the company is yet to provide to their customers.
However, compensation for these goods and services have been received in advance. Therefore, the company cannot justify this particular receipt as a result of which it is classified as a Current Liability in the Financial Statements.
This amount stays as a current liability until the point where the company is able to service this particular debt, after which it is subsequently treated as revenue, and income generated from sales.
The nature of account for unearned revenue is basically a Current Liability.
This is because this is the amount that the company has received in advance from their customer against which they are liable to provide their subsequent services.
The journal entry that is required to record Unearned Revenue is as follows:
Debit – Cash / Bank
Credit – Unearned Revenue (Current Liability)
Examples of unearned revenue mainly occur in cases where it can be seen companies are likely to take payments in advance, like construction companies or service providers, which are reliant on advance service collections.
Therefore, this particular amount is treated as a Current Liability, to the point where the company is able to exercise this advance revenue to be treated as earned revenue.
Converting unearned revenue into earned revenue depends on the service or product delivery timeline. As a matter of fact, it is an essential factor that needs to be embedded in order to determine the exact change of category from unearned revenue to earned revenue.
According to accounting standards, it can be seen that a sale transaction is said to have been completed when the risks of holding and storing these certain goods have been transferred to the other party, i.e. the buyer.
Therefore, this means that sales or sale revenue can only be recorded once the subsequent risks have been passed on, and in most cases, this tends to be the point of delivery of the respective goods and services in this regard.
Therefore, to conclude the information that has been presented above, it can be seen hat unearned revenue is mainly recorded as earned revenue when the proper transaction has been completed in terms of fulfilling the basic requirements, pertaining to the fulfillment of these transactions in terms of risk transfer.
Furthermore, it can also be evaluated that unearned revenue is mainly earned when the company is able to justify the amount it has received in remuneration of the said goods and services.