Under the accrual basis of accounting, the financial transactions are to be recorded as and when they occur. When the seller provides services or sells goods, then he has to recognize the revenue even if the customer has not made payment.
This is in line with the accrual concept. It is the revenue that the company earned after selling its goods or services although it hasn’t received its payment yet.
This recording of transactions is even mandated as per the Revenue recognition principle that defines when revenue is to be recorded. As per AS 9 on revenue recognition, revenue can be only recognized when these two conditions are fulfilled:
It is usually recorded as a current asset because the gap period between earning revenue and receipt of cash is usually less than a year or a working capital cycle. It is shown in balance sheet as current asset when the related revenue is shown in the income statement.
As the payments are received, the accrued revenue gets deducted by the amount of cash received, with no further effect on the income statement. A high accrued revenue signifies that the business is not receiving timely payments for its products or services and can be alarming for the financial health of the company.
The conditions required for booking the accrued revenue are as follows:
Situations when accrued revenue arises and needs to be booked:
Example of accrued revenue:
A sold goods to B on December 30,2019 for Rs 5000. He closes the books of accounts on December 31. He received the payment on January 10,2020. How should he record revenue?
On December 31, 2020, A should recognize the revenue of Rs 5000 after the conditions of revenue recognition have been duly met. Such conditions are
The journal entries to be passed are:
At the point of sales being made:
To Sales revenue
At the time of receipt of cash:
Accrued revenue is the revenue that has been recognized but not yet realized. It is also called unbilled revenue. It is recorded when there is mismatch between time of the payment and delivery of goods and services.
This can arise in following cases:
Presentation of accrued revenue in financial statements:
Accrued revenue is shown as adjusting journal entry under current assets category in the balance sheet and as an earned revenue in the income statement of the company. When the payment is cleared, it is recorded as an adjusting entry to the asset account for accrued revenue.
A bank grants loan to customer of Rs 500000 at 10% per annum on January 1,2020. The amount will be collected after a period of 1 year. After the passage of 1 month, the bank is entitled to a revenue of 1-month interest. Hence, the entry would be:
Interest receivable A/C Dr
To Interest income A/C
Interest receivable of Rs 4167 would be shown as current asset in the balance sheet and as earned revenue in P&L statement as per accrual principle.
ABC IT services company agrees to build a software for PQR company in 12 months for Rs. 400000. According to the contract, ABC is expected to deliver the first milestone in 6 months which is valued at Rs. 250000. A second milestone would be delivered at the end of the contract in another 6 months.
Hence ABC must record accrued revenue at the end of first milestone. The entry would be:
Accrued revenue A/C Dr
To Revenue A/C
After the completion of the milestone and total bill being issued, ABC must record the following:
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.
Cash or bank
Unearned revenues (liability)
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.
Unearned revenues (liability)
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.
Unearned revenues (liability)
Cash or bank
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.
Unearned revenues (XYZ Co.)
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.
Unearned revenues (XYZ Co.)
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.
Revenues are one of the top indicators of a company’s performance. It is because the higher the revenues of a company are, the higher its profits will be as well. However, higher-income doesn’t always mean higher cash flows. Its mainly due to some companies making sales on credit terms, which means they will receive the cash against it in the future.
What is Accrued Revenue?
Accrued revenue is any revenue earned by a company or business for which it hasn’t received a payment at the time of delivering the goods. Accounting standards require a company to recognize revenues when it earns them, not when it receives cash for them. Therefore, companies that make sales on credit terms will always have to record or recognize accrued revenues.
There are various reasons why companies record accrued revenues. Firstly, it is because of the accruals concept of accounting which requires companies to record revenues when earned not when a customer pays for them. Secondly, it also follows the matching principle of accounting, which states that companies should record an expense in the same period as revenues it helped generate.
Practically, accrued revenues can come up due to various types of transactions. For example, it can happen when a company delivers goods but does not bill the customer at the time. Similarly, it can happen for long-term projects, where companies recognize revenues based on the percentage of completion method. Companies can also record accrued revenues on the interest income from loans given to others.
Preconditions for recognizing Accrued Revenue
Companies cannot record accrued revenue in every single case. There are some preconditions attached to recognizing revenues to satisfy the requirements of the accounting standards. Some of the preconditions necessary for recording accrued revenues are as follows.
First, a company must have already earned revenues for it to be able to record them. It means that there should be a delivery of products or services to the company’s customers. If a company has delivered only a part of its products or services from a large contract, it must estimate the portion of the delivered goods and recognize the revenue for that portion only.
Similarly, the company must be able to estimate or calculate the value of the goods or services delivered. In case it cannot measure their value, it cannot recognize revenues related to them. Furthermore, the company must evaluate whether the customer can, with reasonable certainty, pay for the delivered goods.
Lastly, it is also vital for the company to have persuasive evidence of an arrangement for recognizing accrued revenues. This evidence may be in the form of a written or oral agreement with the customer that is binding.
In its most basic form, accrued revenues come in the form of accounts receivable balances from customers to whom a company makes credit sales. When a company makes credit sales to a customer, it must record the accrued revenue related to it when it delivers the goods or services to the customer. The journal entry to record accounts receivable balance and the associated accrued revenues for the customer is as follows.
Before recognizing the accrued revenue for a customer, the company must ascertain that it meets the prerequisites or preconditions needed to record it. If a transaction does not satisfy the preconditions mentioned above, the company cannot record the sale transaction.
Once the customer repays for the goods in the future, the company must remove the related accounts receivable balance. The double entry for the eventual repayment, however, will not affect the related accrued revenue recognized in the accounts. Similarly, if the customer fails to repay the company, the accrued revenue recognized will remain unchanged.
A company, ABC Co., makes sales of $10,000 to a customer. The customer does not make any payment against the revenue but promises to repay the company in 30 days. ABC Co. delivers the goods to the customer. ABC Co. believes the sale transaction meets all the preconditions necessary for it to recognize an accrued revenue.
Therefore, the company must record the revenues from the customer as accrued revenues. The double entry that ABC Co. will use to record the transaction is as follows.
Eventually, when the customer repays the balance, ABC Co. can credit the accounts receivable balance and debit the mode of receipt from the customer.
Accrued revenues are revenues earned by a company but for which the customer hasn’t made a payment. The reason why companies record accrued revenues is to conform with accounting standards and concepts, such as the accruals and matching concepts. However, companies must first ensure a transaction meets the preconditions necessary to recognize it.
Unearned revenue is amount of money that is received by the business for goods and services that is yet to be delivered or rendered. Unearned revenue can also be interpreted as revenue received in advance from customers but the performance of service or delivery of goods would be done later on.
Hence, the business creates the liability in its balance sheet till goods or services are delivered or performed. Popularly, unearned revenues are also known as deferred revenue or advance payments.
Some business models regularly thrive on the basis of unearned revenue. These are businesses selling subscription-based products and which would require advance payments. Popular examples include, rent payments are made in advance, prepaid insurance, airline tickets payments, newspaper subscriptions and payments for the use of software.
Receiving money in advance is very beneficial for the business to thrive. The revenue received early can be used in various ways like prepayment of debt or making requisitions of more inventory.
Recognition of unearned revenue
Unearned revenues provide various clues into how the company would be able to generate revenue in the coming quarters of reporting. The figure of unearned revenue becomes great importance to investors. Netflix is based on subscription model. The coronavirus although resulted in spurge of demand for Netflix.
Not every business has been spared. Take for example football sports club. They usually allow for annual subscription to fans to watch all the games. Manchester United for example would have to refund all the yearly fees it received from football fans for annual ticket membership fees.
This is meant to say things can go both ways in case of unearned revenue. The business may have to refund the unearned revenue in case of adverse circumstances.
There are three ways to record revenue. In case of accrual revenue, revenues are recognized at the time of performance of work. This is the general approach to record revenue and is in line with accounting principles. In case of deferred revenue, which equates to unearned revenue, the cash is received before the revenue has to be recognized as per accrual system of book keeping. T
his approach considers unearned revenue as a liability until the goods or services are delivered or rendered as the case may and then the revenue shall be identified. Another common transaction is when the business receives cash at the same time the goods or services are provided. In that case, revenue will be recorded impromptu.
How Unearned Revenue is Reported?
Unearned revenue is promised service that has not been performed. Hence, such revenue which is technically not a revenue has to be reported. There are two methods to report unearned revenue. These are liability method and income method.
In case of liability method, the unearned revenue is considered as liability. The appropriate reason for this would be that company has not performed the service and hence, the work seems to be pending even though the cash seems to have been received.
Hence, the unearned revenue has to be reported as a liability. At the end of March, the company will make adjusting entry which looks as
Unearned Revenue and How It Is Accounted for in Business
The journal entries would look as :
(To record cash received in advance from customer)
(To record revenue for the services performed)
The same payment of unearned revenue would be treated differently if the company uses income method. The income method approaches towards the unearned revenue as advanced payment as income. The general trade practice is however liability method.
Unearned Revenue in Balance Sheet
The customers do advance payments for the services they expect to be performed within a few months or a year at stretch. Hence, unearned revenue would be recorded under short term liabilities alongside trade payables. This would be reported under the Liabilities side of Balance sheet. Let’s take a short example.
Sinra Inc has received internet subscription for 3-month package from 200 customers at $ 30 dollar per customer per month in the first week of April for April to June package.
Now, in the first week, Sinra Inc has to recognize all of 200 customers as unearned revenue. This would be 200*30*3 = $ 18000
If the balance sheet is made at the end of April month i.e. at April 30, it would look as the following :
The balance sheet also known as the statement of financial position is one of the annual financial reports that exhibit the financial position of a company as at the year-ended.
Share capital and liabilities are both line items of the balance sheet. The statement of financial position is based on the accounting equation, which is also referred to as the balance sheet equation for obvious reasons. The accounting equation is:
ASSETS = LIABILITIES + EQUITY
Although both items are the balance sheet items, there is a number of areas they different. In this article, we will discuss the detail of the difference between share capital and liabilities.
Now let start with capital,
For small entities, share capital is the owner’s contribution to the business i.e. the amount that the owner has invested in the business.
However, for large organizations, share capital is a part of equity which is raised by issuing shares. It refers to the amount of cash funded by potential investors, who later, after investing, become partial owners of the company.
The share capital is divided into several shares at par value, and each share represents ownership. The funds raised by equity financing are typically used to expand the business.
There are two major types of share capital:
Common Stock – Common or ordinary shareholders are the sole owners of the company and have voting rights at board meetings. They receive dividends but only when the company earns a profit. In the case of liquidation, ordinary shareholders are given the last preference i.e. they receive their share of liquidation profit after paying off all the other stakeholders of the company.
Preference Stock – Preference shareholders may or may not have voting rights. They receive fixed dividends, regardless of the company earning profits. In the case of liquidation, preference shareholders have a senior hand over the net assets than the ordinary shareholders.
The liabilities of a company are the cash or amount that it has borrowed from other entities. These are obligations that the company has to perform in the near or later future. Liabilities are classified into two major types on the balance sheet; current liabilities and non-current liabilities.
Current Liabilities – These are short term debts that are to be paid off within a period of 12 months. Accounts payable, interest payable, and rent payable are a few examples of current liabilities.
Non-current Liabilities – These are debts that are to be paid off in the long run i.e. more than a year; for example, a bank loan.
Share Capital vs Liabilities:
Share capital and liabilities are both methods of acquiring cash to provide for the business, but are obtained in extremely different ways.
Share capital is the owners’ contribution or the funds raised by issuance of shares whereas liabilities are the amounts owed by the company to other entities.
Money raised through the issuance of share capital is owned by the company, whereas money obtained through credit or loan is the money of the lender that has to be returned along with interest.
Shareholders receive dividends whereas lenders receive interest. Also, usually in the case of current liabilities, no interest is charged.
In the case of liquidation, creditors are paid off from the net assets before the shareholders.
Shares can be sold and transferred whereas liabilities can not be sold and transferred.
Unearned revenue is the money received by an individual or a company for services that have yet to be provided, or goods that are yet to be delivered. This is a prepayment from the buyer for goods and services to be supplied at a later date.
This would count as a liability for the seller, as the revenue has yet to be earned because the good or service hasn’t been delivered. It is recorded as a liability on a company’s balance sheet.
Companies that have subscription-based products or services have to record unearned revenue. Receiving prepayments can be beneficial for a company that has to purchase inventory or pay interest on debt.
Some examples of unearned revenue are rent payments, prepaid insurance, airline tickets, gift cards, and subscriptions for channels or newspapers.
When the company provides a good or service and hence “earns” the revenue, they debit the unearned revenue account to reduce its balance and credit the revenue account to increase its balance. The unearned revenue is usually a current liability.
If a company didn’t classify the unearned revenue as a liability and instead recognized it as profit or revenue, it would overstate the profit in the income statement and when the service or good is actually provided, the profits would be understated for that time period.
This goes against the matching principle since revenues are being recognized without the related expenses being recognized.
Unearned income is the income received from investments or other sources that are unrelated to employment. Unearned income is income that is not gained through employment, work, or business activities; hence it is different from earned income.
Earned income includes wages, salaries, tips, and self-employment income. Before retirement, unearned income can be an addition to earned income but after retirement, it is often the only source of income.
Taxation is different for earned and unearned income both.
Interest and dividends are the most common types of unearned income. Interest income earned on savings deposit accounts and loans is taxed as ordinary income. Dividends are income from investments and are taxed at ordinary rates or preferred long-term capital gains tax rates.
Some of the common sources of unearned income are the following:
Professional fees earned by an individual or commercial enterprise.
Tips earned in the services sector
Wages earned on the job
Self-employment income, which is recorded tax-wise, on an IRS 1099 form.
Commissions earned on the job, usually in the sales sector.
Bonuses earned on the job, like a Wall Street broker earns for meeting or exceeding company sales/revenue expectations, for example.
Sick leave on the job (yes, getting the flu has a financial impact, according to the IRS.
Personal time-off pay is taken by employees.
Long-term disability benefits again garnered from full or part-time employment.
Meal, transportation, and accommodation reimbursement from employees traveling on the company dime.
Non-cash income earned on the job, such as a vehicle provided to a traveling salesperson by his or her company.
Unearned revenue is a liability for companies and individuals whereas unearned income serves as a supplement to normal earned income for companies and individuals.