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 earned.
Since the company owes money to its clients as the obligations have not been performed yet, unearned revenue is reported as a current liability on a company’s balance sheet.
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 yet invoiced it.
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.
Financial Accounting and Reporting:
Unearned revenue is credit in nature and is reported as a real account in the company’s books. 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, it could record adjusting entries at the end of the year to accrue the revenue 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 per the accounting principle, it can’t record the income in the current period, resulting in unrecorded revenue.