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.
Unearned revenue is the money received by an individual or a company for services or goods that they haven’t been supplied or provided yet to the buyer. This counts as a prepayment from the buyer perspective for goods and services that need to be supplied at a later date to them.
Unearned revenue is recognized as a current liability for the seller’s accounting records, as the revenue is not yet earned because the good or service hasn’t been delivered. It has to be recorded as a liability on a company’s balance sheet.
Businesses that have subscription-based products or services normally received the payment from their customers in advance and they should record the cash they received as unearned revenue as it is the way their business is structured. The revenue is then recognized as the revenues over the period of time over the life of services or subscription.
Receiving prepayments can be advantageous for a company that has to purchase inventory beforehand or pay interest on the debt. Some examples of unearned revenue are rent payments, prepaid insurance, airline tickets, gift cards, and subscriptions for channels or newspapers.
When a company provides the good or service and hence has “earned” the revenue, they have to debit the unearned revenue account in order to reduce its balance and credit the revenue account in order to increase its balance.
The unearned revenue is usually a current liability unless prepayment has been received for the supply of goods or services after a year.
If a company fails to classify the unearned revenue as a liability and instead recognized it as profit or revenue, they are overstating 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 will go against the matching principle because revenues have to be recognized in the period they were earned, along with expenses that related to that period.
Unbilled revenue is revenue that has been earned by a company or individual but not yet recorded on their accounts. Or it is recognized revenue that has been accounted for but no invoices have yet been sent to the customer.
It basically means that the service or good has been provided to the customer but you have not yet billed them. You could say it goes hand in hand with unearned revenue.
When you receive a prepayment from a customer, it is recognized as unearned revenue and since the customer hasn’t been billed an invoice for the good or service, it is unbilled revenue as well.
So to account for unbilled revenues, companies should include a section in their balance sheets for unbilled receivables to recognize revenue for a given period and should count unbilled receivables toward their total revenue even if an invoice has not been generated or sent to the customer.
Unbilled revenue could be treated in two ways depending on the accounting principle the company is adopting, either accrual basis concepts or cash basis.
If they were recording on accrual basis concept then they would have to debit the Account Receivables to decrease its balance and credit the Income or Sales Revenue account to increase its balance.
While it’s necessary for some businesses to establish relationships through unbilled revenue, minimizing the need for such situations can provide a much clearer idea of your total revenue.
As explained above, the main different between unearned revenues and unbilled revenues are due the delivery of services and receiving of cash. For unearned revenues, the company received the payment from its customers before goods or services are provided to the customers.
However, unbilled revenues, the goods or services are already provided or delivered to the customers, but the company have not yet bill or issue invoices to the customers. The payment is not also collected.
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:
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.