Unearned revenue is the cash proceeds received by a company or individual for a service or product that the company or individual still has to deliver to the customer.
It is an advance payment from a customer that is expecting the delivery of services or products at a later date.
The company cannot recognize a revenue amount in the financial statements until the revenue is realized in the company’s accounts, i.e., when the services or products are delivered to the customer either in part or in full. In this case, the company will have received the payment in advance.
Unearned revenue, also calls deferred revenues, is a liability account because it represents the revenue that is not yet earned. After all, the services or products are not yet delivered to the customer.
When the cash is received, a liability account is created with corresponding equal entry in cash received.
This receipt of cash is recorded by debiting the cash account and crediting the current liability account. This entry is performed as follows
Cr_Unearned revenue account xxxx
As soon as the services or products are delivered proportionally, the liability account is reduced with the same amount equal to the number of services or products delivered to the customer.
This will debit the unearned revenue liability account and crediting the revenue earned account in the income statement. This entry is performed as follows.
Dr_Current Liability xxxx
Cr_Revenue earned xxxx
What is unearned revenue?
Unearned revenue is mostly common in companies that provide subscription-based services to their customers.
These services require prepayments for the delivery of those services. The most common examples of unearned revenues that give birth to an unearned revenue liability include payments made in advance for subscriptions, prepaid insurance, legal advisors, tickets purchased for movies, airlines, or trains, prepayments for websites subscriptions or newspapers subscriptions, etc.
Prepayments are beneficial for the company because they can help the company improve the cash flow performance, increase the liquidity ratios, pay interest on loans, and use that cash for many other purposes.
Unearned revenue is financial statements:
Unearned revenues are recognized as the liability account in the current liability section of the balance sheet in the financial statements.
This liability is recognized as an obligation for the company because they owe to their customers in terms of products or services.
Revenue is not recognized yet and recorded as a liability because there are still chances that the contract between the customer and company may still break and the goods or services are not delivered in the future.
In this case, the company will have to repay the cash to the customer unless there is a revision in the contract between them to keep the contract as it is.
Because of this nature of prepayments for the services to deliver, unearned revenue is not recognized as revenue and is recorded as a liability.
Revenue will be recognized when the company completes the required terms set by the IFRS 15 for revenue recognition set by the international financial reporting standards, i.e., delivering the services to the customer.