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.
Unearned revenue, also called deferred revenue is the advance payments received by a company for products or services that will be delivered at a future date.
The company records the unearned revenue as a liability under the current liabilities in the balance sheet.
Unearned revenue represents a liability account because it is revenue not yet earned because the company still owes the products or services to their customers.
When the products and services are delivered over time gradually, the company will recognize the unearned revenue in the revenue account in the income statement.
Unearned revenue is still to be recognized as revenue because the company has not yet completed the obligations of providing the services.
financial reporting on revenue recognition:
IFRS 15 ‘Revenue from Contracts with Customers’ sets 5 principles to determine and complete before revenue is recognized in the income statement. The company recognizing revenue must make sure to complete the following five steps
1) Identify contracts with the customer:
A company making a transaction with the customer and recognizing the revenue must identify the terms and conditions in the contract.
The contract must be agreed with both the parties, services, and goods must be identified, payment terms must be identified, the contract must have a commercial substance, and it is probable that the money will be received which in unearned revenue case is already collected.
2) Identify the performance obligations in the contract:
The contract should identify the performance obligations that the company has to fulfill. These identify the products or services that the company has to deliver to the customer.
3) Determine the transaction price:
The contract between both parties has to determine the transaction price for the goods or services the company has to deliver to the company. These prices should be fair and at arm’s length.
4) Allocate the transaction prices to its relative performance obligations:
When a contract possesses many performance obligations, such as there are many products and services to deliver to the company, each performance obligation should be allocated to its own unique transaction prices.
If the transaction prices are not directly able to be allocated to performance obligations, they should be allocated on a fair estimation.
5) Recognize revenue when the entity satisfies the performance obligation:
The company finally recognize the revenue when they will deliver the services and goods to the customer. Delivery of goods means that the control over them is transferred to the customer.
They have to transfer the complete control to the customer and the customer should have the right to consume all the benefits from the goods.
If the services or goods are transferred gradually over
time, they have to recognize the revenue to the extent to which the services or
goods are transferred to the other party.
Recognition of unearned revenue as revenue in the income statement is limited to the completeness of performance obligations either over time or at once.
The fact is that; unearned revenue is revenue that is not yet earned because the company has not yet played its part in delivering the services or goods to the company.
Unearned revenue is the revenue received from a customer for which the supplies are not yet supplied or the services not yet performed for which the money is received.
This is the cash received by the seller or the company but they have not yet performed their duties.
This is a liability created for the company for which they have to perform or supply the supplies equal to the value of the cash they have already received.
Unearned revenues are useful for the seller for the cash flow performance because they have already received the cash while no service provided yet.
They can use the cash for other useful activities. Unearned revenue is considered as prepayment by the payer for which they still have to receive the services or goods.
Because of this prepayment, the seller has the liability equal to the unearned revenue or the cash received from the payer.
This liability will be written off when goods or services are supplied to the customer at a value equal to the unearned revenue recognized by the seller.
Nature of unearned revenues:
Because the company has received money for a service that they have not performed yet, it creates a liability for the company. unearned revenues are cash received in advance for the services and therefore possess liability nature.
Unearned revenues cannot be recorded in the revenue account of the income statement because it does not fulfill the criteria of revenue recognition of the international financial reporting standards.
If the services are supplied to the customer on a partial basis, they will recognize only partial revenue while remaining still in the liability account.
Entire unearned revenue liability will be set off against revenue only when the value of services provided is equal to the unearned revenue liability account.
Recognition of unearned revenue:
Unearned revenue is recognized as a liability on the company’s balance sheet. It is recorded as a liability because the company has not yet earned the revenue and they owe products or services to a customer.
When the products or services are delivered over time to customers, they are recognized as revenue gradually in the income statement.
When a company accepts cash for unearned revenue, it increases the cash as well as the current liability account. These are both balance sheet items and hence do not affect the income statement items.
Unearned revenue is recorded as a current liability when the products or services are to be delivered in the next 12 months or lower than 12 months.
However, if the products or services are to be delivered in more than 12 months, it is recognized as a non-current liability.
Accounting double entry in the financial statements of the company:
In the beginning, when the company accepts cash for revenue, it is recognized as a liability with a corresponding entry to increase cash or bank.
It is recognized as a liability account because the company still has to provide services or products to the company at a later date.
Here is the example:
Dr Cash or Bank XXXX
Cr Unearned Revenue XXXX
When the company later gradually delivers the services, a debit entry is made to the current liability account hence decreasing the current liability account as the company has now no liability for that amount of delivery of service.
On the other hand, a credit entry is made to the revenue earned hence increasing the revenue account or revenue figure for the company in the income statement. Delivery of services or products may be partial or in full.
Cr Revenue XXXX
Dr Unearned Revenue XXX
If products or services delivered are partial to the total amount of the whole amount, only a partial amount is debited to the current liability account while crediting the revenue earned account.
Along with that if the products or services delivered are in full, the whole amount of the unearned revenue liability account is debited while crediting the revenue earned account in the income statement.
Recognizing unearned revenue in the revenue account without recognizing it in the current liability will overstate the revenue figures and net profit while understating the current liability accounts. This is against the IFRS 15 of international financial reporting standards.
According to IFRS 15 revenue must only be recognized when the obligations for the products or services are delivered to the customer.
This case of recognizing unearned revenue as revenue is a highly risky area in terms of audit engagements because revenue accounts are of the highest figures in the financial statements in most cases.
Examples of unearned revenues:
Let’s suppose a customer John paid $10,000 in advance to ABC Company for parking for three months. When the company accepts the cash, they will record unearned revenue because the company has not yet provided the services to the customer for now.
The company will debit the cash account while credit the current liability account hence balancing the financial statements. When the ABC Company gradually delivers the service to the customer for parking, they will recognize the unearned revenue in the revenue account.
Upon delivering the obligations, ABC Company will debit the current liability account while crediting the revenue account in the income statement.
Cash received by a legal retainer in advance to the services delivered to customers is another example of unearned revenue. The legal retainer has still had to deliver legal services to the customer.
Prepaid insurance received by the
insurance company creates a liability for the insurance company but that is unearned
revenue. Prepaid insurance will create an asset account for the customer.
A company cannot immediately recognize the cash proceeds received in advance as revenue because it is against the guidelines of the IFRS 15 which deals with revenue recognition.
According to IFRS 15, they will recognize the revenue gradually when the services are delivered to the customer with the passage of time.
As compared to revenue recognition, they will have to create a liability account for the unearned revenue.
As the services are delivered, revenue will be recognized with the number of services provided while reducing the liability account with the same amount of revenue recognized in the income statement.